Could The Market Be Wrong About Johnson Controls-Hitachi Air Conditioning India Limited (NSE:JCHAC) Given Its Attractive Financial Prospects?

Johnson Controls-Hitachi Air Conditioning India (NSE:JCHAC) has had a rough three months with its share price down 22%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Johnson Controls-Hitachi Air Conditioning 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Johnson Controls-Hitachi Air Conditioning India

How Do You Calculate Return On Equity?

ROE 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 Johnson Controls-Hitachi Air Conditioning India is:

18% = ₹1.2b ÷ ₹6.7b (Based on the trailing twelve months to December 2019).

The 'return' is the income the business earned over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.18.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learnt 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.

Johnson Controls-Hitachi Air Conditioning India's Earnings Growth And 18% ROE

To start with, Johnson Controls-Hitachi Air Conditioning India's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 11%. Probably as a result of this, Johnson Controls-Hitachi Air Conditioning India was able to see a decent growth of 10% over the last five years.

We then compared Johnson Controls-Hitachi Air Conditioning India's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 17% in the same period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Johnson Controls-Hitachi Air Conditioning India fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Johnson Controls-Hitachi Air Conditioning India Making Efficient Use Of Its Profits?

In Johnson Controls-Hitachi Air Conditioning India's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 5.2% (or a retention ratio of 95%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Johnson Controls-Hitachi Air Conditioning India is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

In total, we are pretty happy with Johnson Controls-Hitachi Air Conditioning India's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 1 risk we have identified for Johnson Controls-Hitachi Air Conditioning India by visiting our risks dashboard for free on our platform here.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.