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

It is hard to get excited after looking at Olectra Greentech's (NSE:OLECTRA) recent performance, when its stock has declined 17% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Olectra Greentech's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Olectra Greentech

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Olectra Greentech is:

8.6% = ₹787m ÷ ₹9.2b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. 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?

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

Olectra Greentech's Earnings Growth And 8.6% ROE

As you can see, Olectra Greentech's ROE looks pretty weak. Not just that, even compared to the industry average of 14%, the company's ROE is entirely unremarkable. Despite this, surprisingly, Olectra Greentech saw an exceptional 59% net income growth over the past five years. We reckon that there could be other factors at play here. 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.

We then compared Olectra Greentech's 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 25% in the same 5-year 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). This then helps them determine if the stock is placed for a bright or bleak future. Is Olectra Greentech fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Olectra Greentech Making Efficient Use Of Its Profits?

Olectra Greentech's three-year median payout ratio to shareholders is 5.0%, which is quite low. This implies that the company is retaining 95% of its profits. So it looks like Olectra Greentech is reinvesting profits heavily to grow its business, which shows in its earnings growth.

While Olectra Greentech has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 1.0% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 23%, over the same period.

Conclusion

In total, it does look like Olectra Greentech has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.