Could The Market Be Wrong About Royal Orchid Hotels Limited (NSE:ROHLTD) Given Its Attractive Financial Prospects?

Royal Orchid Hotels (NSE:ROHLTD) has had a rough three months with its share price down 20%. 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 Royal Orchid Hotels' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Royal Orchid Hotels

How Is ROE Calculated?

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 Royal Orchid Hotels is:

23% = ₹473m ÷ ₹2.1b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.23 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. 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 Royal Orchid Hotels' Earnings Growth And 23% ROE

At first glance, Royal Orchid Hotels seems to have a decent ROE. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. This certainly adds some context to Royal Orchid Hotels' exceptional 45% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Royal Orchid Hotels' 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 33% in the same 5-year period.

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. 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 Royal Orchid Hotels is trading on a high P/E or a low P/E, relative to its industry.

Is Royal Orchid Hotels Using Its Retained Earnings Effectively?

Royal Orchid Hotels' ' three-year median payout ratio is on the lower side at 12% implying that it is retaining a higher percentage (88%) of its profits. So it looks like Royal Orchid Hotels is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Royal Orchid Hotels has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders.

Summary

In total, we are pretty happy with Royal Orchid Hotels' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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. To know the 3 risks we have identified for Royal Orchid Hotels visit our risks dashboard for free.

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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.