Declining Stock and Decent Financials: Is The Market Wrong About Somany Ceramics Limited (NSE:SOMANYCERA)?

With its stock down 19% over the past three months, it is easy to disregard Somany Ceramics (NSE:SOMANYCERA). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Somany Ceramics' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Somany Ceramics

How Do You 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 Somany Ceramics is:

10% = ₹869m ÷ ₹8.5b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.10 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. 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.

Somany Ceramics' Earnings Growth And 10% ROE

When you first look at it, Somany Ceramics' 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. Looking at Somany Ceramics' exceptional 22% five-year net income growth in particular, we are definitely impressed. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Somany Ceramics' 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 26% in the same 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. 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 Somany Ceramics is trading on a high P/E or a low P/E, relative to its industry.

Is Somany Ceramics Using Its Retained Earnings Effectively?

Somany Ceramics has a really low three-year median payout ratio of 14%, meaning that it has the remaining 86% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Somany Ceramics 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 13% of its profits over the next three years. Still, forecasts suggest that Somany Ceramics' future ROE will rise to 17% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we do feel that Somany Ceramics 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.