Touchwood Entertainment Limited (NSE:TOUCHWOOD) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

With its stock down 21% over the past month, it is easy to disregard Touchwood Entertainment (NSE:TOUCHWOOD). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Touchwood Entertainment'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Touchwood Entertainment

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 Touchwood Entertainment is:

8.4% = ₹30m ÷ ₹361m (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 ₹0.08 in profit.

What Has ROE Got To Do With 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.

Touchwood Entertainment's Earnings Growth And 8.4% ROE

It is hard to argue that Touchwood Entertainment's ROE is much good in and of itself. Not just that, even compared to the industry average of 12%, the company's ROE is entirely unremarkable. Despite this, surprisingly, Touchwood Entertainment saw an exceptional 32% net income growth over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Touchwood Entertainment's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 41% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Touchwood Entertainment's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Touchwood Entertainment Using Its Retained Earnings Effectively?

Touchwood Entertainment's three-year median payout ratio to shareholders is 14%, which is quite low. This implies that the company is retaining 86% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Additionally, Touchwood Entertainment has paid dividends over a period of six years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

In total, it does look like Touchwood Entertainment has some positive aspects to its business. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 4 risks we have identified for Touchwood Entertainment by visiting our risks dashboard for free on our platform here.

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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.