Should Weakness in Bajaj Auto Limited's (NSE:BAJAJ-AUTO) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

It is hard to get excited after looking at Bajaj Auto's (NSE:BAJAJ-AUTO) recent performance, when its stock has declined 12% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Bajaj Auto's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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% = ₹75b ÷ ₹310b (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.24.

View our latest analysis for Bajaj Auto

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of Bajaj Auto's Earnings Growth And 24% ROE

To begin with, Bajaj Auto seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 24%. This probably goes some way in explaining Bajaj Auto's moderate 10% growth over the past five years amongst other factors.

As a next step, we compared Bajaj Auto's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 31% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is Bajaj Auto fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Bajaj Auto Making Efficient Use Of 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.

Additionally, Bajaj Auto has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with 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 61%. However, Bajaj Auto's ROE is predicted to rise to 31% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we do feel that Bajaj Auto has some positive attributes. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. 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.