Touchwood Entertainment Limited's (NSE:TOUCHWOOD) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Touchwood Entertainment (NSE:TOUCHWOOD) has had a rough month with its share price down 11%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Touchwood Entertainment's 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Touchwood Entertainment

How To Calculate Return On Equity?

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:

9.6% = ₹35m ÷ ₹359m (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.10 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. 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.

Touchwood Entertainment's Earnings Growth And 9.6% ROE

When you first look at it, Touchwood Entertainment's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 11%. Particularly, the exceptional 35% net income growth seen by Touchwood Entertainment over the past five years is pretty remarkable. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing Touchwood Entertainment's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 38% over the last few years.

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. Is Touchwood Entertainment fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Touchwood Entertainment Making Efficient Use Of Its Profits?

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. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Touchwood Entertainment is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend.

Conclusion

In total, it does look like Touchwood Entertainment has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. 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. Our risks dashboard would have the 5 risks we have identified for Touchwood Entertainment.

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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.