With its stock down 4.5% over the past three months, it is easy to disregard ZF Commercial Vehicle Control Systems India (NSE:ZFCVINDIA). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on ZF Commercial Vehicle Control Systems India's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 ZF Commercial Vehicle Control Systems India is:
6.6% = ₹1.3b ÷ ₹20b (Based on the trailing twelve months to December 2021).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.07 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
ZF Commercial Vehicle Control Systems India's Earnings Growth And 6.6% ROE
As you can see, ZF Commercial Vehicle Control Systems India's ROE looks pretty weak. Not just that, even compared to the industry average of 11%, the company's ROE is entirely unremarkable. For this reason, ZF Commercial Vehicle Control Systems India's five year net income decline of 16% is not surprising given its 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.
Next, when we compared with the industry, which has shrunk its earnings at a rate of 1.2% in the same period, we still found ZF Commercial Vehicle Control Systems India's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 ZF Commercial Vehicle Control Systems India's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is ZF Commercial Vehicle Control Systems India Using Its Retained Earnings Effectively?
ZF Commercial Vehicle Control Systems India's low three-year median payout ratio of 9.0% (or a retention ratio of 91%) 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. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Additionally, ZF Commercial Vehicle Control Systems India has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.
In total, we're a bit ambivalent about ZF Commercial Vehicle Control Systems India's performance. 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. You can see the 1 risk we have identified for ZF Commercial Vehicle Control Systems India 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. 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.