Vesuvius India's (NSE:VESUVIUS) stock is up by a considerable 5.7% over the past month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Vesuvius India's ROE in this article.
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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
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 Vesuvius India is:
6.0% = ₹505m ÷ ₹8.4b (Based on the trailing twelve months to March 2021).
The 'return' is the profit 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 ₹0.06 in profit.
What Is The Relationship Between ROE And 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.
Vesuvius India's Earnings Growth And 6.0% ROE
As you can see, Vesuvius India's ROE looks pretty weak. Not just that, even compared to the industry average of 10%, the company's ROE is entirely unremarkable. For this reason, Vesuvius India's five year net income decline of 6.5% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared Vesuvius India's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 9.7% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Vesuvius India's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Vesuvius India Using Its Retained Earnings Effectively?
Vesuvius India's low three-year median payout ratio of 19% (implying that it retains the remaining 81% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Additionally, Vesuvius India has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.
On the whole, we feel that the performance shown by Vesuvius India can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 2 risks we have identified for Vesuvius India.
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