Power & Instrumental (Gujarat) Limited's (NSE:PIGL) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Power & Instrumental (Gujarat)'s (NSE:PIGL) stock is up by a considerable 74% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to Power & Instrumental (Gujarat)'s ROE today.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Power & Instrumental (Gujarat)

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Power & Instrumental (Gujarat) is:

12% = ₹57m ÷ ₹474m (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.12 in profit.

What Has ROE Got To Do With 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Power & Instrumental (Gujarat)'s Earnings Growth And 12% ROE

When you first look at it, Power & Instrumental (Gujarat)'s ROE doesn't look that attractive. However, its ROE is similar to the industry average of 12%, so we won't completely dismiss the company. But Power & Instrumental (Gujarat) saw a five year net income decline of 21% over the past five years. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

That being said, we compared Power & Instrumental (Gujarat)'s performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 19% in the same 5-year 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. 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 Power & Instrumental (Gujarat) is trading on a high P/E or a low P/E, relative to its industry.

Is Power & Instrumental (Gujarat) Using Its Retained Earnings Effectively?

Power & Instrumental (Gujarat)'s low three-year median payout ratio of 6.0% (implying that it retains the remaining 94% of its profits) comes as a surprise when you pair it with the shrinking earnings. This typically shouldn't be the case when a company is retaining most of its earnings. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Summary

In total, we're a bit ambivalent about Power & Instrumental (Gujarat)'s performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 5 risks we have identified for Power & Instrumental (Gujarat) by visiting our risks dashboard for free on our platform here.

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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.