Should Weakness in Escorts Kubota Limited's (NSE:ESCORTS) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Escorts Kubota (NSE:ESCORTS) has had a rough three months with its share price down 5.7%. 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 Escorts Kubota's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Escorts Kubota

How To 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 Escorts Kubota is:

12% = ₹12b ÷ ₹98b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.12 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Escorts Kubota's Earnings Growth And 12% ROE

At first glance, Escorts Kubota's ROE doesn't look very promising. However, its ROE is similar to the industry average of 14%, so we won't completely dismiss the company. Even so, Escorts Kubota has shown a fairly decent growth in its net income which grew at a rate of 14%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. 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.

As a next step, we compared Escorts Kubota's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 28% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Escorts Kubota's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Escorts Kubota Using Its Retained Earnings Effectively?

Escorts Kubota's three-year median payout ratio to shareholders is 12% (implying that it retains 88% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Additionally, Escorts Kubota 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 29% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Summary

In total, it does look like Escorts Kubota has some positive aspects to its business. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.