PSP Projects (NSE:PSPPROJECT) has had a great run on the share market with its stock up by a significant 21% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to PSP Projects' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 PSP Projects is:
20% = ₹1.1b ÷ ₹5.4b (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.20 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
PSP Projects' Earnings Growth And 20% ROE
To begin with, PSP Projects seems to have a respectable ROE. Especially when compared to the industry average of 8.1% the company's ROE looks pretty impressive. This probably laid the ground for PSP Projects' moderate 12% net income growth seen over the past five years.
When you consider the fact that the industry earnings have shrunk at a rate of 1.7% in the same period, the company's net income growth is pretty remarkable.
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. If you're wondering about PSP Projects''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is PSP Projects Using Its Retained Earnings Effectively?
PSP Projects has a low three-year median payout ratio of 14%, meaning that the company retains the remaining 86% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Moreover, PSP Projects is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend.
In total, we are pretty happy with PSP Projects' 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 1 risk we have identified for PSP Projects by visiting our risks dashboard for free on our platform here.
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.
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