It is hard to get excited after looking at United Drilling Tools' (NSE:UNIDT) recent performance, when its stock has declined 20% over the past month. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on United Drilling Tools' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You Calculate Return On Equity?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for United Drilling Tools is:
21% = ₹470m ÷ ₹2.2b (Based on the trailing twelve months to December 2021).
The 'return' refers to a company's earnings over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.21.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.
United Drilling Tools' Earnings Growth And 21% ROE
To begin with, United Drilling Tools seems to have a respectable ROE. Especially when compared to the industry average of 13% the company's ROE looks pretty impressive. This probably laid the ground for United Drilling Tools' significant 27% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing United Drilling Tools' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 25% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 United Drilling Tools is trading on a high P/E or a low P/E, relative to its industry.
Is United Drilling Tools Efficiently Re-investing Its Profits?
United Drilling Tools' three-year median payout ratio to shareholders is 9.8%, which is quite low. This implies that the company is retaining 90% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Moreover, United Drilling Tools is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend.
On the whole, we feel that United Drilling Tools' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 2 risks we have identified for United Drilling Tools.
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.