Ahlada Engineers Limited's (NSE:AHLADA) Stock Is Going Strong: Have Financials A Role To Play?

Ahlada Engineers (NSE:AHLADA) has had a great run on the share market with its stock up by a significant 82% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Ahlada Engineers' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Ahlada Engineers

How Do You Calculate Return On Equity?

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 Ahlada Engineers is:

5.5% = ₹63m ÷ ₹1.2b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.05 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Ahlada Engineers' Earnings Growth And 5.5% ROE

It is quite clear that Ahlada Engineers' ROE is rather low. Even compared to the average industry ROE of 8.0%, the company's ROE is quite dismal. Although, we can see that Ahlada Engineers saw a modest net income growth of 12% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Ahlada Engineers' 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 10%.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Ahlada Engineers is trading on a high P/E or a low P/E, relative to its industry.

Is Ahlada Engineers Using Its Retained Earnings Effectively?

In Ahlada Engineers' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 18% (or a retention ratio of 82%), which suggests that the company is investing most of its profits to grow its business.

While Ahlada Engineers has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Conclusion

On the whole, we do feel that Ahlada Engineers has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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 3 risks we have identified for Ahlada Engineers 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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