Declining Stock and Solid Fundamentals: Is The Market Wrong About Shriram Pistons & Rings Limited (NSE:SHRIPISTON)?

It is hard to get excited after looking at Shriram Pistons & Rings' (NSE:SHRIPISTON) recent performance, when its stock has declined 18% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Shriram Pistons & Rings' ROE.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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How To 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 Shriram Pistons & Rings is:

21% = ₹4.8b ÷ ₹22b (Based on the trailing twelve months to December 2024).

The 'return' is the profit over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.21 in profit.

See our latest analysis for Shriram Pistons & Rings

Why Is ROE Important For 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. 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.

Shriram Pistons & Rings' Earnings Growth And 21% ROE

To begin with, Shriram Pistons & Rings seems to have a respectable ROE. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. Probably as a result of this, Shriram Pistons & Rings was able to see an impressive net income growth of 42% over the last five years. However, there could also be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Shriram Pistons & Rings' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 28%.

Earnings growth is an important metric to consider when valuing a stock. 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 Shriram Pistons & Rings''s valuation, check out this gauge of its price-to-earnings ratio , as compared to its industry.

Is Shriram Pistons & Rings Using Its Retained Earnings Effectively?

Shriram Pistons & Rings' ' three-year median payout ratio is on the lower side at 9.2% implying that it is retaining a higher percentage (91%) of its profits. So it looks like Shriram Pistons & Rings is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Shriram Pistons & Rings has been paying dividends over a period of eight years. 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's future payout ratio is expected to rise to 12% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

On the whole, we feel that Shriram Pistons & Rings' performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.