Bharat Heavy Electricals Limited's (NSE:BHEL) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

With its stock down 9.4% over the past month, it is easy to disregard Bharat Heavy Electricals (NSE:BHEL). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Bharat Heavy Electricals' 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.

See our latest analysis for Bharat Heavy Electricals

How Is ROE Calculated?

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 Bharat Heavy Electricals is:

1.1% = ₹2.8b ÷ ₹244b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.01.

What Is The Relationship Between ROE And 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. 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.

Bharat Heavy Electricals' Earnings Growth And 1.1% ROE

It is hard to argue that Bharat Heavy Electricals' ROE is much good in and of itself. Even compared to the average industry ROE of 14%, the company's ROE is quite dismal. However, we we're pleasantly surprised to see that Bharat Heavy Electricals grew its net income at a significant rate of 27% in the last five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Bharat Heavy Electricals' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 30% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Bharat Heavy Electricals is trading on a high P/E or a low P/E, relative to its industry.

Is Bharat Heavy Electricals Using Its Retained Earnings Effectively?

Bharat Heavy Electricals has a three-year median payout ratio of 31% (where it is retaining 69% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Bharat Heavy Electricals is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Bharat Heavy Electricals has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 23% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 11%, over the same period.

Conclusion

In total, it does look like Bharat Heavy Electricals has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.