Crompton Greaves Consumer Electricals Limited's (NSE:CROMPTON) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Crompton Greaves Consumer Electricals (NSE:CROMPTON) has had a great run on the share market with its stock up by a significant 9.0% over the last month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Crompton Greaves Consumer Electricals' ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To Calculate Return On Equity?

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 Crompton Greaves Consumer Electricals is:

15% = ₹5.3b ÷ ₹36b (Based on the trailing twelve months to December 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.15 in profit.

View our latest analysis for Crompton Greaves Consumer Electricals

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Crompton Greaves Consumer Electricals' Earnings Growth And 15% ROE

At first glance, Crompton Greaves Consumer Electricals seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.6%. Needless to say, we are quite surprised to see that Crompton Greaves Consumer Electricals' net income shrunk at a rate of 2.8% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

However, when we compared Crompton Greaves Consumer Electricals' 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.

Earnings growth is an important metric to consider when valuing a stock. 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 Crompton Greaves Consumer Electricals is trading on a high P/E or a low P/E, relative to its industry.

Is Crompton Greaves Consumer Electricals Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 34% (or a retention ratio of 66%) which is pretty normal, Crompton Greaves Consumer Electricals' declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Crompton Greaves Consumer Electricals has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 36%. As a result, Crompton Greaves Consumer Electricals' ROE is not expected to change by much either, which we inferred from the analyst estimate of 18% for future ROE.

Conclusion

In total, it does look like Crompton Greaves Consumer Electricals has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.