Are Robust Financials Driving The Recent Rally In Prakash Pipes Limited's (NSE:PPL) Stock?

Prakash Pipes (NSE:PPL) has had a great run on the share market with its stock up by a significant 48% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Prakash Pipes' ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Prakash Pipes

How To 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 Prakash Pipes is:

23% = ₹743m ÷ ₹3.2b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.23.

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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Prakash Pipes' Earnings Growth And 23% ROE

At first glance, Prakash Pipes seems to have a decent ROE. Especially when compared to the industry average of 14% the company's ROE looks pretty impressive. This probably laid the ground for Prakash Pipes' significant 27% net income growth seen over the past five years. We reckon that there could also 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 Prakash Pipes' 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 20% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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. 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 Prakash Pipes is trading on a high P/E or a low P/E, relative to its industry.

Is Prakash Pipes Making Efficient Use Of Its Profits?

Prakash Pipes has a really low three-year median payout ratio of 6.1%, meaning that it has the remaining 94% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Moreover, Prakash Pipes is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend.

Conclusion

In total, we are pretty happy with Prakash Pipes' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard would have the 2 risks we have identified for Prakash Pipes.

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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.