It is hard to get excited after looking at Escorts' (NSE:ESCORTS) recent performance, when its stock has declined 2.7% over the past week. 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 Escorts' 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Escorts is:
16% = ₹7.3b ÷ ₹45b (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.16.
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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Escorts' Earnings Growth And 16% ROE
To begin with, Escorts seems to have a respectable ROE. Especially when compared to the industry average of 9.3% the company's ROE looks pretty impressive. This probably laid the ground for Escorts' significant 26% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Escorts' 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 8.0% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Escorts''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Escorts Making Efficient Use Of Its Profits?
Escorts' ' three-year median payout ratio is on the lower side at 4.5% implying that it is retaining a higher percentage (95%) of its profits. So it looks like Escorts is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Additionally, Escorts 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 14% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.
Overall, we are quite pleased with Escorts' performance. 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 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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