Are Robust Financials Driving The Recent Rally In The Grob Tea Company Limited's (NSE:GROBTEA) Stock?

Most readers would already be aware that Grob Tea's (NSE:GROBTEA) stock increased significantly by 29% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Grob Tea's 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Grob Tea

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 Grob Tea is:

27% = ₹226m ÷ ₹830m (Based on the trailing twelve months to September 2020).

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 ₹0.27 in profit.

What Is The Relationship Between ROE And 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 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.

Grob Tea's Earnings Growth And 27% ROE

To begin with, Grob Tea has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 9.6% the company's ROE is quite impressive. As a result, Grob Tea's exceptional 24% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Grob Tea'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 18% 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). Doing so will help them establish if the stock's future looks promising or ominous. 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 Grob Tea is trading on a high P/E or a low P/E, relative to its industry.

Is Grob Tea Making Efficient Use Of Its Profits?

Grob Tea's ' three-year median payout ratio is on the lower side at 13% implying that it is retaining a higher percentage (87%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Besides, Grob Tea has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

On the whole, we feel that Grob Tea's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard would have the 2 risks we have identified for Grob Tea.

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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.
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