Will Weakness in Mazda Limited's (NSE:MAZDA) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 9.6% over the past three months, it is easy to disregard Mazda (NSE:MAZDA). 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. Specifically, we decided to study Mazda's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Mazda

How Is ROE Calculated?

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 Mazda is:

13% = ₹180m ÷ ₹1.4b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.13 in profit.

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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Mazda's Earnings Growth And 13% ROE

When you first look at it, Mazda's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 8.1% doesn't go unnoticed by us. Consequently, this likely laid the ground for the decent growth of 8.1% seen over the past five years by Mazda. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Therefore, the growth in earnings could also be the result of other factors. Such as- high earnings retention or the company belonging to a high growth industry.

We then performed a comparison between Mazda's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 7.4% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Mazda's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Mazda Using Its Retained Earnings Effectively?

Mazda has a healthy combination of a moderate three-year median payout ratio of 27% (or a retention ratio of 73%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Additionally, Mazda 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.

Summary

Overall, we are quite pleased with Mazda's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 3 risks we have identified for Mazda 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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