Linc Pen & Plastics Limited's (NSE:LINCPEN) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Linc Pen & Plastics' (NSE:LINCPEN) stock is up by a considerable 20% over the past week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Linc Pen & Plastics' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Linc Pen & Plastics

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 Linc Pen & Plastics is:

3.4% = ₹44m ÷ ₹1.3b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.03 in profit.

What Is The Relationship Between ROE And 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. 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 Linc Pen & Plastics' Earnings Growth And 3.4% ROE

It is hard to argue that Linc Pen & Plastics' ROE is much good in and of itself. Even when compared to the industry average of 9.3%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 14% seen by Linc Pen & Plastics over the last five years is not surprising. 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.

However, when we compared Linc Pen & Plastics' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 18% in the same period. This is quite worrisome.

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 Linc Pen & Plastics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Linc Pen & Plastics Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 28% (that is, a retention ratio of 72%), the fact that Linc Pen & Plastics' earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Linc Pen & Plastics has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

On the whole, we feel that the performance shown by Linc Pen & Plastics 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 4 risks we have identified for Linc Pen & Plastics.

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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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