Are Parag Milk Foods Limited's (NSE:PARAGMILK) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

With its stock down 10% over the past three months, it is easy to disregard Parag Milk Foods (NSE:PARAGMILK). 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 Parag Milk Foods' ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Parag Milk Foods

How To Calculate Return On Equity?

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 Parag Milk Foods is:

4.3% = ₹405m ÷ ₹9.3b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.04 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Parag Milk Foods' Earnings Growth And 4.3% ROE

It is quite clear that Parag Milk Foods' ROE is rather low. Even when compared to the industry average of 11%, the ROE figure is pretty disappointing. However, the moderate 18% net income growth seen by Parag Milk Foods over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. 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.

We then performed a comparison between Parag Milk Foods' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 16% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. 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 Parag Milk Foods is trading on a high P/E or a low P/E, relative to its industry.

Is Parag Milk Foods Making Efficient Use Of Its Profits?

Parag Milk Foods has a low three-year median payout ratio of 7.0%, meaning that the company retains the remaining 93% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Besides, Parag Milk Foods has been paying dividends over a period of four years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 6.5% of its profits over the next three years. Regardless, the future ROE for Parag Milk Foods is predicted to rise to 9.0% despite there being not much change expected in its payout ratio.

Summary

On the whole, we do feel that Parag Milk Foods has some positive attributes. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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