Pentagon Rubber Limited's (NSE:PENTAGON) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Pentagon Rubber (NSE:PENTAGON) has had a rough three months with its share price down 27%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Pentagon Rubber's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Pentagon Rubber

How Do You Calculate Return On Equity?

ROE 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 Pentagon Rubber is:

9.7% = ₹29m ÷ ₹302m (Based on the trailing twelve months to September 2024).

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 ₹0.10 in profit.

Why Is ROE Important For 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 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.

Pentagon Rubber's Earnings Growth And 9.7% ROE

When you first look at it, Pentagon Rubber's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 15%, the company's ROE leaves us feeling even less enthusiastic. However, we we're pleasantly surprised to see that Pentagon Rubber grew its net income at a significant rate of 23% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Pentagon Rubber's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 27% 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). Doing so will help them establish if the stock's future looks promising or ominous. 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 Pentagon Rubber is trading on a high P/E or a low P/E, relative to its industry.

Is Pentagon Rubber Using Its Retained Earnings Effectively?

Pentagon Rubber doesn't pay any regular dividends currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Summary

On the whole, we do feel that Pentagon Rubber has some positive attributes. 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. 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. You can see the 4 risks we have identified for Pentagon Rubber by visiting our risks dashboard for free on our platform here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.