Declining Stock and Decent Financials: Is The Market Wrong About Narmada Agrobase Limited (NSE:NARMADA)?

Narmada Agrobase (NSE:NARMADA) has had a rough three months with its share price down 14%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Narmada Agrobase's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Narmada Agrobase

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 Narmada Agrobase is:

5.3% = ₹7.7m ÷ ₹145m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.05.

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. 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.

A Side By Side comparison of Narmada Agrobase's Earnings Growth And 5.3% ROE

It is hard to argue that Narmada Agrobase's ROE is much good in and of itself. Even when compared to the industry average of 10%, the ROE figure is pretty disappointing. In spite of this, Narmada Agrobase was able to grow its net income considerably, at a rate of 27% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared Narmada Agrobase'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 19% 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. If you're wondering about Narmada Agrobase's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Narmada Agrobase Making Efficient Use Of Its Profits?

Narmada Agrobase has a really low three-year median payout ratio of 15%, meaning that it has the remaining 85% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

While Narmada Agrobase has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Summary

In total, it does look like Narmada Agrobase has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 3 risks we have identified for Narmada Agrobase visit our risks dashboard for free.

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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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