CEAT Limited's (NSE:CEATLTD) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?
Most readers would already be aware that CEAT's (NSE:CEATLTD) stock increased significantly by 43% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to CEAT'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 Do You Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for CEAT is:
11% = ₹4.7b ÷ ₹44b (Based on the trailing twelve months to March 2025).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.11 in profit.
See our latest analysis for CEAT
What Has ROE Got To Do With 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 CEAT's Earnings Growth And 11% ROE
At first glance, CEAT's ROE doesn't look very promising. However, its ROE is similar to the industry average of 12%, so we won't completely dismiss the company. Particularly, the exceptional 21% net income growth seen by CEAT over the past five years is pretty remarkable. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.
We then compared CEAT'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.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is CEATLTD fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is CEAT Using Its Retained Earnings Effectively?
CEAT has a really low three-year median payout ratio of 22%, meaning that it has the remaining 78% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Additionally, CEAT 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 18% over the next three years. As a result, the expected drop in CEAT's payout ratio explains the anticipated rise in the company's future ROE to 18%, over the same period.
Summary
On the whole, we do feel that CEAT has some positive attributes. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
Valuation is complex, but we're here to simplify it.
Discover if CEAT might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.