Sundaram Brake Linings Limited's (NSE:SUNDRMBRAK) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Sundaram Brake Linings (NSE:SUNDRMBRAK) has had a great run on the share market with its stock up by a significant 16% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Sundaram Brake Linings' 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Sundaram Brake Linings

How Is ROE Calculated?

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 Sundaram Brake Linings is:

6.4% = ₹53m ÷ ₹829m (Based on the trailing twelve months to December 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.06 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Sundaram Brake Linings' Earnings Growth And 6.4% ROE

As you can see, Sundaram Brake Linings' ROE looks pretty weak. A comparison with the industry shows that the company's ROE is pretty similar to the average industry ROE of 6.7%. However, the modest 17% net income growth seen by Sundaram Brake Linings over the past five years is a positive sign. Given the low ROE, it is likely that there could be some other aspects that are driving this growth as well. 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.

Given that the industry shrunk its earnings at a rate of 0.9% in the same period, the net income growth of the company is quite impressive.

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. This then helps them determine if the stock is placed for a bright or bleak future. What is SUNDRMBRAK worth today? The intrinsic value infographic in our free research report helps visualize whether SUNDRMBRAK is currently mispriced by the market.

Is Sundaram Brake Linings Using Its Retained Earnings Effectively?

Sundaram Brake Linings doesn't pay any dividend, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.

Conclusion

In total, it does look like Sundaram Brake Linings has some positive aspects to its business. 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. You can see the 1 risk we have identified for Sundaram Brake Linings by visiting our risks dashboard for free on our platform here.

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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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