Is Swaraj Engines Limited's (NSE:SWARAJENG) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Most readers would already be aware that Swaraj Engines' (NSE:SWARAJENG) stock increased significantly by 46% over the past 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. Specifically, we decided to study Swaraj Engines' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Swaraj Engines

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 Swaraj Engines is:

26% = ₹620m ÷ ₹2.4b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.26 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

A Side By Side comparison of Swaraj Engines' Earnings Growth And 26% ROE

To start with, Swaraj Engines' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 8.3%. Probably as a result of this, Swaraj Engines was able to see a decent growth of 8.3% over the last five years.

As a next step, we compared Swaraj Engines' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 11% 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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Swaraj Engines''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Swaraj Engines Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 39% (implying that the company retains 61% of its profits), it seems that Swaraj Engines is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Swaraj Engines has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

On the whole, we feel that Swaraj Engines' performance has been quite good. 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 respectable 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. Our risks dashboard would have the 2 risks we have identified for Swaraj Engines.

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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. 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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