Subros Limited's (NSE:SUBROS) Stock Is Going Strong: Have Financials A Role To Play?

Subros' (NSE:SUBROS) stock is up by a considerable 36% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Subros' ROE in this article.

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.

See our latest analysis for Subros

How Do You Calculate Return On Equity?

ROE 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 Subros is:

3.2% = ₹237m ÷ ₹7.4b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.03 in profit.

What Is The Relationship Between ROE And 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Subros' Earnings Growth And 3.2% ROE

It is hard to argue that Subros' ROE is much good in and of itself. Even when compared to the industry average of 5.4%, the ROE figure is pretty disappointing. Subros was still able to see a decent net income growth of 14% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Subros' 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 2.9%.

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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Subros is trading on a high P/E or a low P/E, relative to its industry.

Is Subros Efficiently Re-investing Its Profits?

In Subros' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 11% (or a retention ratio of 89%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Subros 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.

Summary

On the whole, we do feel that Subros has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Subros.

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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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