Minda Industries (NSE:MINDAIND) has had a great run on the share market with its stock up by a significant 34% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Minda Industries' 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.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Minda Industries is:
12% = ₹4.4b ÷ ₹35b (Based on the trailing twelve months to September 2021).
The 'return' is the yearly profit. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.12 in profit.
Why Is ROE Important For 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Minda Industries' Earnings Growth And 12% ROE
When you first look at it, Minda Industries' ROE doesn't look that attractive. However, its ROE is similar to the industry average of 11%, so we won't completely dismiss the company. However, Minda Industries has seen a flattish net income growth over the past five years, which is not saying much. Bear in mind, the company's ROE is not very high. Hence, this provides some context to the flat earnings growth seen by the company.
As a next step, we compared Minda Industries' performance with the industry and discovered the industry has shrunk at a rate of 2.7% in the same period meaning that the company has been shrinking its earnings at a rate lower than the industry. This does appease the negative sentiment around the company to a certain extent.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Minda Industries is trading on a high P/E or a low P/E, relative to its industry.
Is Minda Industries Making Efficient Use Of Its Profits?
Minda Industries has a low three-year median payout ratio of 11% (or a retention ratio of 89%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.
Moreover, Minda Industries has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 8.2% over the next three years. As a result, the expected drop in Minda Industries' payout ratio explains the anticipated rise in the company's future ROE to 19%, over the same period.
Overall, we have mixed feelings about Minda Industries. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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.