Hind Rectifiers Limited's (NSE:HIRECT) Stock Is Going Strong: Is the Market Following Fundamentals?

Hind Rectifiers' (NSE:HIRECT) stock is up by a considerable 17% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Hind Rectifiers' 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 Hind Rectifiers

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 Hind Rectifiers is:

9.2% = ₹90m ÷ ₹976m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.09.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Hind Rectifiers' Earnings Growth And 9.2% ROE

At first glance, Hind Rectifiers' ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 7.1% which we definitely can't overlook. Particularly, the substantial 60% net income growth seen by Hind Rectifiers over the past five years is impressive . That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So, there might well be other reasons for the earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

As a next step, we compared Hind Rectifiers' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 10%.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Hind Rectifiers is trading on a high P/E or a low P/E, relative to its industry.

Is Hind Rectifiers Efficiently Re-investing Its Profits?

Hind Rectifiers has a really low three-year median payout ratio of 6.4%, meaning that it has the remaining 94% left over to reinvest into its business. So it looks like Hind Rectifiers is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Hind Rectifiers has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

On the whole, we feel that Hind Rectifiers' performance has been quite good. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. To know the 4 risks we have identified for Hind Rectifiers visit our risks dashboard for free.

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This article by Simply Wall St is general in nature. 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.
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