Is Elgi Equipments Limited's (NSE:ELGIEQUIP) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Most readers would already be aware that Elgi Equipments' (NSE:ELGIEQUIP) stock increased significantly by 11% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Elgi Equipments' 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.

See our latest analysis for Elgi Equipments

How Do You Calculate Return On Equity?

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 Elgi Equipments is:

28% = ₹4.1b ÷ ₹15b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.28.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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 Elgi Equipments' Earnings Growth And 28% ROE

First thing first, we like that Elgi Equipments has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 17% also doesn't go unnoticed by us. As a result, Elgi Equipments' exceptional 41% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Elgi Equipments' 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 22% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Elgi Equipments fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Elgi Equipments Using Its Retained Earnings Effectively?

Elgi Equipments' three-year median payout ratio to shareholders is 19%, which is quite low. This implies that the company is retaining 81% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Besides, Elgi Equipments has been paying dividends for at least ten years or more. 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 rise to 28% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 19% over the same period.

Summary

On the whole, we feel that Elgi Equipments' 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.