Are GP Petroleums Limited's (NSE:GULFPETRO) Mixed Financials The Reason For Its Gloomy Performance on The Stock Market?

It is hard to get excited after looking at GP Petroleums' (NSE:GULFPETRO) recent performance, when its stock has declined 13% over the past three months. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study GP Petroleums' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for GP Petroleums

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for GP Petroleums is:

4.3% = ₹94m ÷ ₹2.2b (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.04.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 GP Petroleums' Earnings Growth And 4.3% ROE

As you can see, GP Petroleums' ROE looks pretty weak. Not just that, even compared to the industry average of 11%, the company's ROE is entirely unremarkable. Thus, the low net income growth of 4.2% seen by GP Petroleums over the past five years could probably be the result of it having a lower ROE.

Next, on comparing with the industry net income growth, we found that GP Petroleums' reported growth was lower than the industry growth of 5.7% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 GP Petroleums is trading on a high P/E or a low P/E, relative to its industry.

Is GP Petroleums Making Efficient Use Of Its Profits?

A low three-year median payout ratio of 24% (implying that the company retains the remaining 76% of its income) suggests that GP Petroleums is retaining most of its profits. This should be reflected in its earnings growth number, but that's not the case. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, GP Petroleums has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

In total, we're a bit ambivalent about GP Petroleums' performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 3 risks we have identified for GP Petroleums.

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This article by Simply Wall St is general in nature. 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.
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