Are Reliance Industries Limited's (NSE:RELIANCE) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

It is hard to get excited after looking at Reliance Industries' (NSE:RELIANCE) recent performance, when its stock has declined 13% over the past three months. 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 Reliance Industries' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Reliance Industries

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Reliance Industries is:

8.4% = ₹782b ÷ ₹9.3t (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 ₹0.08 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Reliance Industries' Earnings Growth And 8.4% ROE

As you can see, Reliance Industries' ROE looks pretty weak. Not just that, even compared to the industry average of 16%, the company's ROE is entirely unremarkable. Although, we can see that Reliance Industries saw a modest net income growth of 13% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Reliance Industries' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 27% in the same period.

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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Reliance Industries''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Reliance Industries Using Its Retained Earnings Effectively?

Reliance Industries has a low three-year median payout ratio of 9.4%, meaning that the company retains the remaining 91% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Moreover, Reliance Industries is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 9.6% of its profits over the next three years. As a result, Reliance Industries' ROE is not expected to change by much either, which we inferred from the analyst estimate of 9.9% for future ROE.

Summary

Overall, we feel that Reliance Industries certainly does have some positive factors to consider. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. 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.