Is The Market Rewarding Reliance Industrial Infrastructure Limited (NSE:RIIL) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?
With its stock down 12% over the past three months, it is easy to disregard Reliance Industrial Infrastructure (NSE:RIIL). 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. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to Reliance Industrial Infrastructure's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Reliance Industrial Infrastructure
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 Reliance Industrial Infrastructure is:
2.6% = ₹97m ÷ ₹3.7b (Based on the trailing twelve months to March 2020).
The 'return' refers to a company's earnings over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.03 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Industrial Infrastructure's Earnings Growth And 2.6% ROE
It is hard to argue that Reliance Industrial Infrastructure's ROE is much good in and of itself. Even compared to the average industry ROE of 9.9%, the company's ROE is quite dismal. For this reason, Reliance Industrial Infrastructure's five year net income decline of 18% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
So, as a next step, we compared Reliance Industrial Infrastructure's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 10% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Reliance Industrial Infrastructure fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Reliance Industrial Infrastructure Efficiently Re-investing Its Profits?
Looking at its three-year median payout ratio of 32% (or a retention ratio of 68%) which is pretty normal, Reliance Industrial Infrastructure's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Additionally, Reliance Industrial Infrastructure has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.
Conclusion
Overall, we have mixed feelings about Reliance Industrial Infrastructure. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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 Reliance Industrial Infrastructure.
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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. Thank you for reading.