Petronet LNG (NSE:PETRONET) has had a rough month with its share price down 4.2%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Petronet LNG'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
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 Petronet LNG is:
24% = ₹30b ÷ ₹128b (Based on the trailing twelve months to September 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.24 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.
Petronet LNG's Earnings Growth And 24% ROE
To start with, Petronet LNG's ROE looks acceptable. On comparing with the average industry ROE of 15% the company's ROE looks pretty remarkable. This certainly adds some context to Petronet LNG's decent 11% net income growth seen over the past five years.
We then compared Petronet LNG'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 7.7% in the same period.
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. 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 Petronet LNG is trading on a high P/E or a low P/E, relative to its industry.
Is Petronet LNG Making Efficient Use Of Its Profits?
Petronet LNG has a healthy combination of a moderate three-year median payout ratio of 35% (or a retention ratio of 65%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
Additionally, Petronet LNG has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 62% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.
Overall, we are quite pleased with Petronet LNG's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.