Are Bharat Heavy Electricals Limited's (NSE:BHEL) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

It is hard to get excited after looking at Bharat Heavy Electricals' (NSE:BHEL) recent performance, when its stock has declined 20% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Bharat Heavy Electricals' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Bharat Heavy Electricals

How To 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 Bharat Heavy Electricals is:

1.8% = ₹4.4b ÷ ₹242b (Based on the trailing twelve months to September 2024).

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 ₹0.02 in profit.

What Has ROE Got To Do With 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. 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 Bharat Heavy Electricals' Earnings Growth And 1.8% ROE

It is quite clear that Bharat Heavy Electricals' ROE is rather low. Even compared to the average industry ROE of 13%, the company's ROE is quite dismal. Despite this, surprisingly, Bharat Heavy Electricals saw an exceptional 38% net income growth over the past five years. Therefore, there could be other reasons behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing Bharat Heavy Electricals' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 33% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about Bharat Heavy Electricals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Bharat Heavy Electricals Using Its Retained Earnings Effectively?

Bharat Heavy Electricals' three-year median payout ratio is a pretty moderate 31%, meaning the company retains 69% of its income. So it seems that Bharat Heavy Electricals is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Additionally, Bharat Heavy Electricals 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 21% over the next three years. As a result, the expected drop in Bharat Heavy Electricals' payout ratio explains the anticipated rise in the company's future ROE to 11%, over the same period.

Summary

In total, it does look like Bharat Heavy Electricals has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.