Goodyear India Limited's (NSE:GOODYEAR) Stock Is Going Strong: Have Financials A Role To Play?

Most readers would already be aware that Goodyear India's (NSE:GOODYEAR) stock increased significantly by 18% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Goodyear India's ROE today.

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 Goodyear India

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 Goodyear India is:

7.4% = ₹689m ÷ ₹9.3b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.07 in profit.

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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Goodyear India's Earnings Growth And 7.4% ROE

As you can see, Goodyear India's ROE looks pretty weak. However, the fact that it is higher than the industry average of 5.4% makes us a bit more interested. But seeing Goodyear India's five year net income decline of 6.8% over the past five years, we might rethink that. Bear in mind, the company does have a low ROE. It is just that the industry ROE is lower. So that's what might be causing earnings growth to shrink.

However, when we compared Goodyear India's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 2.9% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. 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 Goodyear India fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Goodyear India Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 29% (where it is retaining 71% of its profits), Goodyear India has seen a decline in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Goodyear India has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

Overall, we feel that Goodyear India certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard will have the 1 risk we have identified for Goodyear India.

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This article by Simply Wall St is general in nature. 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.
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