Craftsman Automation Limited's (NSE:CRAFTSMAN) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Craftsman Automation (NSE:CRAFTSMAN) has had a rough three months with its share price down 19%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Craftsman Automation's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Craftsman Automation

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Craftsman Automation is:

9.8% = ₹2.7b ÷ ₹28b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.10 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. 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.

A Side By Side comparison of Craftsman Automation's Earnings Growth And 9.8% ROE

At first glance, Craftsman Automation's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 14% either. However, we we're pleasantly surprised to see that Craftsman Automation grew its net income at a significant rate of 28% in the last five years. We reckon that there could 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.

Next, on comparing Craftsman Automation's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 28% over the last few years.

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). Doing so will help them establish if the stock's future looks promising or ominous. 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 Craftsman Automation is trading on a high P/E or a low P/E, relative to its industry.

Is Craftsman Automation Making Efficient Use Of Its Profits?

Craftsman Automation has a really low three-year median payout ratio of 7.8%, meaning that it has the remaining 92% left over to reinvest into its business. So it looks like Craftsman Automation is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Craftsman Automation has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 5.0% over the next three years. As a result, the expected drop in Craftsman Automation's payout ratio explains the anticipated rise in the company's future ROE to 18%, over the same period.

Conclusion

Overall, we feel that Craftsman Automation certainly does have some positive factors to consider. 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.