Munjal Showa Limited's (NSE:MUNJALSHOW) Financials Are Too Obscure To Link With Current Share Price Momentum: What's In Store For the Stock?

Munjal Showa's (NSE:MUNJALSHOW) stock is up by a considerable 23% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to Munjal Showa's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Munjal Showa

How Do You 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 Munjal Showa is:

3.0% = ₹191m ÷ ₹6.3b (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.03 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.

Munjal Showa's Earnings Growth And 3.0% ROE

It is quite clear that Munjal Showa's ROE is rather low. Not just that, even compared to the industry average of 5.3%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 7.3% seen by Munjal Showa over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared Munjal Showa's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 3.8% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Munjal Showa's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Munjal Showa Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 29% (that is, a retention ratio of 71%), the fact that Munjal Showa's earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Munjal Showa 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

In total, we're a bit ambivalent about Munjal Showa's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 5 risks we have identified for Munjal Showa visit our risks dashboard for free.

When trading Munjal Showa or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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