Aaron Industries Limited's (NSE:AARON) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

Most readers would already be aware that Aaron Industries' (NSE:AARON) stock increased significantly by 20% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Aaron Industries' 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.

Check out our latest analysis for Aaron Industries

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 Aaron Industries is:

14% = ₹16m ÷ ₹108m (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 ₹0.14 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Aaron Industries' Earnings Growth And 14% ROE

On the face of it, Aaron Industries' ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 9.0% doesn't go unnoticed by us. Particularly, the substantial 33% net income growth seen by Aaron Industries over the past five years is impressive . That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Hence, there might be some other aspects that are causing earnings to grow. Such as- high earnings retention or the company belonging to a high growth industry.

We then compared Aaron Industries' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 7.6% in the same period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is Aaron Industries fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Aaron Industries Using Its Retained Earnings Effectively?

Aaron Industries' three-year median payout ratio to shareholders is 22%, which is quite low. This implies that the company is retaining 78% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

While Aaron Industries has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Conclusion

Overall, we are quite pleased with Aaron Industries' performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard would have the 4 risks we have identified for Aaron Industries.

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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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