Is Weakness In Elgi Equipments Limited (NSE:ELGIEQUIP) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

It is hard to get excited after looking at Elgi Equipments' (NSE:ELGIEQUIP) recent performance, when its stock has declined 15% over the past three months. 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. In this article, we decided to focus on Elgi Equipments' ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Elgi Equipments

How Is ROE Calculated?

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 Elgi Equipments is:

19% = ₹3.3b ÷ ₹17b (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 ₹0.19 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. 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.

Elgi Equipments' Earnings Growth And 19% ROE

To begin with, Elgi Equipments seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 15%. Probably as a result of this, Elgi Equipments was able to see an impressive net income growth of 39% over the last five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

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 28% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Elgi Equipments is trading on a high P/E or a low P/E, relative to its industry.

Is Elgi Equipments Making Efficient Use Of Its Profits?

Elgi Equipments' three-year median payout ratio to shareholders is 20%, which is quite low. This implies that the company is retaining 80% of its profits. So it looks like Elgi Equipments is reinvesting profits heavily to grow its business, which shows in its earnings growth.

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 is expected to keep paying out approximately 23% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 20%.

Summary

On the whole, we feel that Elgi Equipments' performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.