CG Power and Industrial Solutions Limited's (NSE:CGPOWER) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 22% over the past three months, it is easy to disregard CG Power and Industrial Solutions (NSE:CGPOWER). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to CG Power and Industrial Solutions' ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for CG Power and Industrial Solutions

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for CG Power and Industrial Solutions is:

25% = ₹9.3b ÷ ₹37b (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.25 in profit.

What Is The Relationship Between ROE And 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of CG Power and Industrial Solutions' Earnings Growth And 25% ROE

To start with, CG Power and Industrial Solutions' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 15%. This probably laid the ground for CG Power and Industrial Solutions' significant 52% net income growth seen over the past five years. We reckon that there could also be other factors at play here. 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.

We then compared CG Power and Industrial Solutions' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 34% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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. 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 CG Power and Industrial Solutions is trading on a high P/E or a low P/E, relative to its industry.

Is CG Power and Industrial Solutions Making Efficient Use Of Its Profits?

CG Power and Industrial Solutions' ' three-year median payout ratio is on the lower side at 22% implying that it is retaining a higher percentage (78%) of its profits. So it looks like CG Power and Industrial Solutions is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, CG Power and Industrial Solutions 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 22%. As a result, CG Power and Industrial Solutions' ROE is not expected to change by much either, which we inferred from the analyst estimate of 27% for future ROE.

Summary

On the whole, we feel that CG Power and Industrial Solutions' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.