Can Mixed Fundamentals Have A Negative Impact on V.S.T. Tillers Tractors Limited (NSE:VSTTILLERS) Current Share Price Momentum?

V.S.T. Tillers Tractors' (NSE:VSTTILLERS) stock is up by a considerable 10% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on V.S.T. Tillers Tractors' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for V.S.T. Tillers Tractors

How To Calculate Return On Equity?

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 V.S.T. Tillers Tractors is:

7.5% = ₹471m ÷ ₹6.2b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.08.

Why Is ROE Important For 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. 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.

V.S.T. Tillers Tractors' Earnings Growth And 7.5% ROE

It is quite clear that V.S.T. Tillers Tractors' ROE is rather low. A comparison with the industry shows that the company's ROE is pretty similar to the average industry ROE of 8.2%. Therefore, it might not be wrong to say that the five year net income decline of 15% seen by V.S.T. Tillers Tractors was possibly a result of the disappointing ROE.

That being said, we compared V.S.T. Tillers Tractors' 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 7.5% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 V.S.T. Tillers Tractors is trading on a high P/E or a low P/E, relative to its industry.

Is V.S.T. Tillers Tractors Using Its Retained Earnings Effectively?

When we piece together V.S.T. Tillers Tractors' low three-year median payout ratio of 20% (where it is retaining 80% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. 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, V.S.T. Tillers Tractors 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.

Summary

On the whole, we feel that the performance shown by V.S.T. Tillers Tractors can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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 V.S.T. Tillers Tractors.

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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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