Is Aarvi Encon Limited's (NSE:AARVI) Latest Stock Performance A Reflection Of Its Financial Health?

Aarvi Encon (NSE:AARVI) has had a great run on the share market with its stock up by a significant 18% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Aarvi Encon's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Aarvi Encon

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Aarvi Encon is:

13% = ₹100m ÷ ₹793m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.13.

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.

Aarvi Encon's Earnings Growth And 13% ROE

At first glance, Aarvi Encon's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 4.9% which we definitely can't overlook. Consequently, this likely laid the ground for the decent growth of 14% seen over the past five years by Aarvi Encon. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Therefore, the growth in earnings could also be the result of other factors. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

Next, on comparing Aarvi Encon's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 14% 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). This then helps them determine if the stock is placed for a bright or bleak future. Is Aarvi Encon fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Aarvi Encon Making Efficient Use Of Its Profits?

In Aarvi Encon's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 19% (or a retention ratio of 81%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Aarvi Encon is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend.

Summary

In total, we are pretty happy with Aarvi Encon's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 2 risks we have identified for Aarvi Encon visit our risks dashboard for free.

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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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