With its stock down 7.9% over the past month, it is easy to disregard ITC (NSE:ITC). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to ITC's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
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 ITC is:
23% = ₹135b ÷ ₹596b (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.23 in profit.
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. 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.
A Side By Side comparison of ITC's Earnings Growth And 23% ROE
To begin with, ITC seems to have a respectable ROE. On comparing with the average industry ROE of 17% the company's ROE looks pretty remarkable. This probably laid the ground for ITC's moderate 8.8% net income growth seen over the past five years.
As a next step, we compared ITC's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 17% in the same period.
Earnings growth is a huge factor in stock valuation. 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 ITC fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is ITC Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 56% (or a retention ratio of 44%) for ITC suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Besides, ITC has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 90% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.
In total, it does look like ITC has some positive aspects to its business. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. 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. 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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