Declining Stock and Solid Fundamentals: Is The Market Wrong About Cello World Limited (NSE:CELLO)?

Cello World (NSE:CELLO) has had a rough three months with its share price down 25%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Cello World's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

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 Cello World is:

16% = ₹3.6b ÷ ₹22b (Based on the trailing twelve months to December 2024).

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 ₹0.16 in profit.

View our latest analysis for Cello World

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. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Cello World's Earnings Growth And 16% ROE

To start with, Cello World's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 8.6%. This probably laid the ground for Cello World's moderate 19% net income growth seen over the past five years.

As a next step, we compared Cello World's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 18% in the same period.

Earnings growth is a huge factor in stock valuation. 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. 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 Cello World is trading on a high P/E or a low P/E, relative to its industry.

Is Cello World Using Its Retained Earnings Effectively?

In Cello World's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 9.5% (or a retention ratio of 90%), which suggests that the company is investing most of its profits to grow its business.

While Cello World has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 17% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Conclusion

On the whole, we feel that Cello World's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.