Bajaj Auto Limited's (NSE:BAJAJ-AUTO) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Bajaj Auto (NSE:BAJAJ-AUTO) has had a rough three months with its share price down 25%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Bajaj Auto's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Bajaj Auto

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Bajaj Auto is:

24% = ₹74b ÷ ₹310b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.24 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Bajaj Auto's Earnings Growth And 24% ROE

At first glance, Bajaj Auto seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 22%. This probably goes some way in explaining Bajaj Auto's moderate 10.0% growth over the past five years amongst other factors.

We then compared Bajaj Auto's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 28% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Bajaj Auto's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Bajaj Auto Efficiently Re-investing Its Profits?

While Bajaj Auto has a three-year median payout ratio of 66% (which means it retains 34% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Besides, Bajaj Auto has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 60%. Regardless, the future ROE for Bajaj Auto is predicted to rise to 33% despite there being not much change expected in its payout ratio.

Conclusion

In total, it does look like Bajaj Auto has some positive aspects to its business. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.