Declining Stock and Solid Fundamentals: Is The Market Wrong About PDS Limited (NSE:PDSL)?

With its stock down 12% over the past month, it is easy to disregard PDS (NSE:PDSL). 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 PDS' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for PDS

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 PDS is:

13% = ₹2.2b ÷ ₹17b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.13 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

PDS' Earnings Growth And 13% ROE

At first glance, PDS' ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 8.3% doesn't go unnoticed by us. Particularly, the substantial 23% net income growth seen by PDS over the past five years is impressive . That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So, there might well be other reasons for the earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

We then performed a comparison between PDS' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 21% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about PDS''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is PDS Making Efficient Use Of Its Profits?

PDS' three-year median payout ratio is a pretty moderate 31%, meaning the company retains 69% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like PDS is reinvesting its earnings efficiently.

Moreover, PDS is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 26%. However, PDS' ROE is predicted to rise to 20% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we are pretty happy with PDS' performance. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.