Menon Bearings Limited's (NSE:MENONBE) Stock Is Going Strong: Have Financials A Role To Play?

Menon Bearings (NSE:MENONBE) has had a great run on the share market with its stock up by a significant 37% over the last three months. 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. In this article, we decided to focus on Menon Bearings' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Menon Bearings

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Menon Bearings is:

14% = ₹131m ÷ ₹949m (Based on the trailing twelve months to September 2020).

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 ₹0.14 in profit.

What Has ROE Got To Do With 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.

Menon Bearings' Earnings Growth And 14% ROE

At first glance, Menon Bearings' ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 5.4% doesn't go unnoticed by us. However, Menon Bearings has seen a flattish net income growth over the past five years, which is not saying much. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. Hence, this goes some way in explaining the flat earnings growth.

As a next step, we compared Menon Bearings' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 2.9% 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 Menon Bearings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Menon Bearings Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 40% (implying that the company keeps 60% of its income) over the last three years, Menon Bearings has seen a negligible amount of growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Menon Bearings 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.

Conclusion

In total, it does look like Menon Bearings has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return and is reinvesting a huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Menon Bearings' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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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