Ador Welding Limited (NSE:ADORWELD) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Ador Welding (NSE:ADORWELD) has had a great run on the share market with its stock up by a significant 22% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Ador Welding's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Ador Welding

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 Ador Welding is:

4.0% = ₹97m ÷ ₹2.4b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.04 in profit.

Why Is ROE Important For 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. 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.

Ador Welding's Earnings Growth And 4.0% ROE

As you can see, Ador Welding's ROE looks pretty weak. Not just that, even compared to the industry average of 8.1%, the company's ROE is entirely unremarkable. Thus, the low net income growth of 2.7% seen by Ador Welding over the past five years could probably be the result of it having a lower ROE.

Next, on comparing with the industry net income growth, we found that Ador Welding's reported growth was lower than the industry growth of 7.5% in the same period, which is not something we like to see.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Ador Welding's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Ador Welding Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 33% (implying that the company retains the remaining 67% of its income), Ador Welding's earnings growth was quite low. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Ador Welding has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

Overall, we have mixed feelings about Ador Welding. 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. Our risks dashboard would have the 3 risks we have identified for Ador Welding.

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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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