Reliance Industries Limited's (NSE:RELIANCE) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Reliance Industries (NSE:RELIANCE) has had a rough three months with its share price down 4.6%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Reliance Industries' 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 Reliance Industries

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 Reliance Industries is:

8.4% = ₹799b ÷ ₹9.5t (Based on the trailing twelve months to December 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.08 in profit.

What Has ROE Got To Do With 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. 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.

Reliance Industries' Earnings Growth And 8.4% ROE

It is quite clear that Reliance Industries' ROE is rather low. Even compared to the average industry ROE of 14%, the company's ROE is quite dismal. However, the moderate 12% net income growth seen by Reliance Industries over the past five years is definitely a positive. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

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 30% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Reliance Industries''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Reliance Industries Efficiently Re-investing Its Profits?

In Reliance Industries' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 9.4% (or a retention ratio of 91%), which suggests that the company is investing most of its profits to grow its 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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 13% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Summary

In total, it does look like Reliance Industries has some positive aspects to its business. 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.