Shakti Pumps (India) Limited's (NSE:SHAKTIPUMP) Stock Is Going Strong: Have Financials A Role To Play?
Most readers would already be aware that Shakti Pumps (India)'s (NSE:SHAKTIPUMP) stock increased significantly by 59% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Shakti Pumps (India)'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Shakti Pumps (India)
How Is ROE Calculated?
Return on equity 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 Shakti Pumps (India) is:
3.0% = ₹86m ÷ ₹2.9b (Based on the trailing twelve months to December 2019).
The 'return' is the yearly profit. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.03 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learnt 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.
Shakti Pumps (India)'s Earnings Growth And 3.0% ROE
It is quite clear that Shakti Pumps (India)'s ROE is rather low. Even when compared to the industry average of 11%, the ROE figure is pretty disappointing. Although, we can see that Shakti Pumps (India) saw a modest net income growth of 13% 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.
As a next step, we compared Shakti Pumps (India)'s net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 15% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Shakti Pumps (India) is trading on a high P/E or a low P/E, relative to its industry.
Is Shakti Pumps (India) Making Efficient Use Of Its Profits?
Shakti Pumps (India)'s three-year median payout ratio to shareholders is 19% (implying that it retains 81% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Moreover, Shakti Pumps (India) is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.
Summary
Overall, we feel that Shakti Pumps (India) certainly does have some positive factors to consider. 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.
Our risks dashboard would have the 5 risks we have identified for Shakti Pumps (India).
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.