Declining Stock and Decent Financials: Is The Market Wrong About Vardhman Textiles Limited (NSE:VTL)?

It is hard to get excited after looking at Vardhman Textiles' (NSE:VTL) recent performance, when its stock has declined 9.9% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Vardhman Textiles' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Vardhman Textiles

How Is ROE Calculated?

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 Vardhman Textiles is:

12% = ₹9.7b ÷ ₹84b (Based on the trailing twelve months to December 2022).

The 'return' is the yearly profit. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.12 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Vardhman Textiles' Earnings Growth And 12% ROE

At first glance, Vardhman Textiles' ROE doesn't look very promising. However, its ROE is similar to the industry average of 9.8%, so we won't completely dismiss the company. Having said that, Vardhman Textiles has shown a modest net income growth of 20% over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Vardhman Textiles' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 19% in the same period.

Earnings growth is a huge factor in stock valuation. 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. 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 Vardhman Textiles is trading on a high P/E or a low P/E, relative to its industry.

Is Vardhman Textiles Making Efficient Use Of Its Profits?

Vardhman Textiles has a low three-year median payout ratio of 15%, meaning that the company retains the remaining 85% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Besides, Vardhman Textiles has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. 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 13%. As a result, Vardhman Textiles' ROE is not expected to change by much either, which we inferred from the analyst estimate of 12% for future ROE.

Summary

On the whole, we do feel that Vardhman Textiles has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.