Should Weakness in MRF Limited's (NSE:MRF) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

MRF (NSE:MRF) has had a rough three months with its share price down 5.3%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to MRF's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for MRF

How Is ROE Calculated?

Return on equity 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 MRF is:

11% = ₹19b ÷ ₹177b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.11 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 MRF's Earnings Growth And 11% ROE

When you first look at it, MRF's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 12%. Even so, MRF has shown a fairly decent growth in its net income which grew at a rate of 9.5%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that MRF's reported growth was lower than the industry growth of 27% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about MRF's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is MRF Using Its Retained Earnings Effectively?

MRF's three-year median payout ratio to shareholders is 4.7% (implying that it retains 95% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Besides, MRF has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 4.8% of its profits over the next three years. As a result, MRF's ROE is not expected to change by much either, which we inferred from the analyst estimate of 12% for future ROE.

Summary

In total, it does look like MRF has some positive aspects to its business. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.