Are Strong Financial Prospects The Force That Is Driving The Momentum In Sheela Foam Limited's NSE:SFL) Stock?

Sheela Foam's (NSE:SFL) stock is up by a considerable 56% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Sheela Foam's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Sheela Foam

How To Calculate Return On Equity?

Return on equity 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 Sheela Foam is:

21% = ₹2.1b ÷ ₹10b (Based on the trailing twelve months to December 2020).

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 ₹0.21.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Sheela Foam's Earnings Growth And 21% ROE

To start with, Sheela Foam's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 9.4%. This probably laid the ground for Sheela Foam's moderate 13% net income growth seen over the past five years.

We then compared Sheela Foam's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 6.2% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Sheela Foam's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Sheela Foam Making Efficient Use Of Its Profits?

Summary

In total, we are pretty happy with Sheela Foam's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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. 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.
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