Sterling Tools Limited's (NSE:STERTOOLS) Stock Is Going Strong: Have Financials A Role To Play?

Sterling Tools (NSE:STERTOOLS) has had a great run on the share market with its stock up by a significant 11% over the last week. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Sterling Tools' ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Sterling Tools

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 Sterling Tools is:

11% = ₹469m ÷ ₹4.2b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.11 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. 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 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.

Sterling Tools' Earnings Growth And 11% ROE

On the face of it, Sterling Tools' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 13%. Having said that, Sterling Tools has shown a modest net income growth of 11% over the past five years. 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 example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared Sterling Tools' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 20% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. 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 Sterling Tools fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Sterling Tools Efficiently Re-investing Its Profits?

Sterling Tools has a low three-year median payout ratio of 15%, meaning that the company retains the remaining 85% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Moreover, Sterling Tools is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 8.4% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 16%, over the same period.

Conclusion

In total, it does look like Sterling Tools has some positive aspects to its business. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.