Declining Stock and Decent Financials: Is The Market Wrong About Filatex India Limited (NSE:FILATEX)?

With its stock down 18% over the past month, it is easy to disregard Filatex India (NSE:FILATEX). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Filatex India's ROE in this article.

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 Filatex India

How Do You 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 Filatex India is:

10% = ₹1.3b ÷ ₹12b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.10 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 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.

Filatex India's Earnings Growth And 10% ROE

When you first look at it, Filatex India's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 7.9%, is definitely interesting. But then again, seeing that Filatex India's net income shrunk at a rate of 3.3% in the past five years, makes us think again. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. Therefore, the decline in earnings could also be the result of this.

That being said, we compared Filatex India's 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 19% in the same 5-year period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Filatex India fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Filatex India Using Its Retained Earnings Effectively?

Filatex India's low three-year median payout ratio of 7.4% (or a retention ratio of 93%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

In addition, Filatex India has been paying dividends over a period of three years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

In total, it does look like Filatex India has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return and is reinvesting a huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 3 risks we have identified for Filatex India visit our risks dashboard for free.

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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.