Hindustan Oil Exploration Company Limited's (NSE:HINDOILEXP) Stock Is Going Strong: Is the Market Following Fundamentals?

Most readers would already be aware that Hindustan Oil Exploration's (NSE:HINDOILEXP) stock increased significantly by 25% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Hindustan Oil Exploration'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Hindustan Oil Exploration

How Do You 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 Hindustan Oil Exploration is:

13% = ₹887m ÷ ₹7.0b (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.13.

What Is The Relationship Between ROE And 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.

Hindustan Oil Exploration's Earnings Growth And 13% ROE

When you first look at it, Hindustan Oil Exploration's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 9.2%, is definitely interesting. Even more so after seeing Hindustan Oil Exploration's exceptional 30% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence, there might be some other aspects that are causing earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

As a next step, we compared Hindustan Oil Exploration's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 0.3%.

Earnings growth is a huge factor in stock valuation. 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. Is Hindustan Oil Exploration fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Hindustan Oil Exploration Making Efficient Use Of Its Profits?

Given that Hindustan Oil Exploration doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

In total, we are pretty happy with Hindustan Oil Exploration's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 2 risks we have identified for Hindustan Oil Exploration 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. 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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