Welspun Living Limited's (NSE:WELSPUNLIV) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

It is hard to get excited after looking at Welspun Living's (NSE:WELSPUNLIV) recent performance, when its stock has declined 18% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Welspun Living's ROE today.

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 Welspun Living

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 Welspun Living is:

15% = ₹7.0b ÷ ₹47b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.15 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned 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.

A Side By Side comparison of Welspun Living's Earnings Growth And 15% ROE

To start with, Welspun Living's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 8.2%. This certainly adds some context to Welspun Living's decent 6.4% net income growth seen over the past five years.

As a next step, we compared Welspun Living's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 21% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 Welspun Living is trading on a high P/E or a low P/E, relative to its industry.

Is Welspun Living Using Its Retained Earnings Effectively?

Welspun Living's three-year median payout ratio to shareholders is 1.4% (implying that it retains 99% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Additionally, Welspun Living has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 9.1% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Summary

In total, we are pretty happy with Welspun Living'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 a good amount of growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.