Should Weakness in Isgec Heavy Engineering Limited's (NSE:ISGEC) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 23% over the past three months, it is easy to disregard Isgec Heavy Engineering (NSE:ISGEC). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Isgec Heavy Engineering's ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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How Do You Calculate Return On Equity?

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 Isgec Heavy Engineering is:

9.4% = ₹2.6b ÷ ₹27b (Based on the trailing twelve months to December 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.09 in profit.

See our latest analysis for Isgec Heavy Engineering

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Isgec Heavy Engineering's Earnings Growth And 9.4% ROE

On the face of it, Isgec Heavy Engineering's ROE is not much to talk about. Next, when compared to the average industry ROE of 15%, the company's ROE leaves us feeling even less enthusiastic. Isgec Heavy Engineering was still able to see a decent net income growth of 10% over the past five years. So, the growth in the company's earnings could probably have been caused by other variables. 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 Isgec Heavy Engineering'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 26% in the same 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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Isgec Heavy Engineering is trading on a high P/E or a low P/E , relative to its industry.

Is Isgec Heavy Engineering Making Efficient Use Of Its Profits?

Isgec Heavy Engineering'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.

Moreover, Isgec Heavy Engineering is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

On the whole, we do feel that Isgec Heavy Engineering has some positive attributes. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 1 risk we have identified for Isgec Heavy Engineering visit our risks dashboard for free.

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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.