Kaveri Seed Company Limited's (NSE:KSCL) Stock Is Going Strong: Have Financials A Role To Play?

Kaveri Seed (NSE:KSCL) has had a great run on the share market with its stock up by a significant 21% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Kaveri Seed's ROE in this article.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Kaveri Seed

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 Kaveri Seed is:

17% = ₹2.8b ÷ ₹17b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.17 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Kaveri Seed's Earnings Growth And 17% ROE

To begin with, Kaveri Seed seems to have a respectable ROE. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. However, for some reason, the higher returns aren't reflected in Kaveri Seed's meagre five year net income growth average of 2.1%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that Kaveri Seed's reported growth was lower than the industry growth of 17% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for KSCL? You can find out in our latest intrinsic value infographic research report.

Is Kaveri Seed Making Efficient Use Of Its Profits?

A low three-year median payout ratio of 8.9% (implying that the company retains the remaining 91% of its income) suggests that Kaveri Seed is retaining most of its profits. However, the low earnings growth number doesn't reflect this as high growth usually follows high profit retention. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Kaveri Seed has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

In total, it does look like Kaveri Seed has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.