CEAT Limited's (NSE:CEATLTD) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

Most readers would already be aware that CEAT's (NSE:CEATLTD) stock increased significantly by 21% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on CEAT'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.

See our latest analysis for CEAT

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 CEAT is:

16% = ₹6.5b ÷ ₹41b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.16.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of CEAT's Earnings Growth And 16% ROE

To start with, CEAT's ROE looks acceptable. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. Probably as a result of this, CEAT was able to see a decent growth of 18% over the last five years.

Next, on comparing with the industry net income growth, we found that CEAT's reported growth was lower than the industry growth of 23% over the last few years, which is not something we like to see.

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. Is CEAT fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is CEAT Making Efficient Use Of Its Profits?

CEAT has a low three-year median payout ratio of 19%, meaning that the company retains the remaining 81% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

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 is expected to keep paying out approximately 15% of its profits over the next three years. Accordingly, forecasts suggest that CEAT's future ROE will be 16% which is again, similar to the current ROE.

Conclusion

On the whole, we feel that CEAT's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.