Declining Stock and Solid Fundamentals: Is The Market Wrong About Amara Raja Batteries Limited (NSE:AMARAJABAT)?

Amara Raja Batteries (NSE:AMARAJABAT) has had a rough month with its share price down 4.1%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Amara Raja Batteries' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Amara Raja Batteries

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 Amara Raja Batteries is:

15% = ₹5.9b ÷ ₹39b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.15.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Amara Raja Batteries' Earnings Growth And 15% ROE

To start with, Amara Raja Batteries' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 7.4%. Probably as a result of this, Amara Raja Batteries was able to see a decent growth of 5.6% over the last five years.

Next, on comparing with the industry net income growth, we found that Amara Raja Batteries' reported growth was lower than the industry growth of 11% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Amara Raja Batteries''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Amara Raja Batteries Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 25% (implying that the company retains 75% of its profits), it seems that Amara Raja Batteries is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Amara Raja Batteries has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

In total, we are pretty happy with Amara Raja Batteries' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings.

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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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