Chennai Petroleum Corporation Limited's (NSE:CHENNPETRO) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 11% over the past three months, it is easy to disregard Chennai Petroleum (NSE:CHENNPETRO). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Chennai Petroleum's 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 Chennai Petroleum

How Do You Calculate Return On Equity?

Return on equity 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 Chennai Petroleum is:

29% = ₹25b ÷ ₹88b (Based on the trailing twelve months to June 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 ₹0.29 in profit.

What Has ROE Got To Do With 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. 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.

Chennai Petroleum's Earnings Growth And 29% ROE

First thing first, we like that Chennai Petroleum has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 16% which is quite remarkable. As a result, Chennai Petroleum's exceptional 60% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Chennai Petroleum's 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 27% in the same 5-year 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. If you're wondering about Chennai Petroleum's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chennai Petroleum Using Its Retained Earnings Effectively?

Chennai Petroleum's three-year median payout ratio to shareholders is 11%, which is quite low. This implies that the company is retaining 89% 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.

Moreover, Chennai Petroleum is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend.

Conclusion

Overall, we are quite pleased with Chennai Petroleum'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 substantial growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.