Shriram Pistons & Rings Limited (NSE:SHRIPISTON) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Shriram Pistons & Rings (NSE:SHRIPISTON) has had a great run on the share market with its stock up by a significant 47% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Shriram Pistons & Rings' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Shriram Pistons & Rings

How To Calculate Return On Equity?

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 Shriram Pistons & Rings is:

4.6% = ₹486m ÷ ₹11b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.05.

Why Is ROE Important For 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.

Shriram Pistons & Rings' Earnings Growth And 4.6% ROE

It is quite clear that Shriram Pistons & Rings' ROE is rather low. Even when compared to the industry average of 6.2%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 19% seen by Shriram Pistons & Rings was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

As a next step, we compared Shriram Pistons & Rings' performance with the industry and found thatShriram Pistons & Rings' performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 0.7% in the same period, which is a slower than the company.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Shriram Pistons & Rings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shriram Pistons & Rings Using Its Retained Earnings Effectively?

Shriram Pistons & Rings' low three-year median payout ratio of 18% (or a retention ratio of 82%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Additionally, Shriram Pistons & Rings has paid dividends over a period of four years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

Overall, we have mixed feelings about Shriram Pistons & Rings. 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. 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. Our risks dashboard would have the 4 risks we have identified for Shriram Pistons & Rings.

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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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