Patanjali Foods Limited's (NSE:PATANJALI) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Patanjali Foods (NSE:PATANJALI) has had a great run on the share market with its stock up by a significant 14% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study Patanjali Foods' ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Patanjali Foods

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 Patanjali Foods is:

9.2% = ₹9.9b ÷ ₹108b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.09 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Patanjali Foods' Earnings Growth And 9.2% ROE

At first glance, Patanjali Foods' ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 11%, we may spare it some thought. But Patanjali Foods saw a five year net income decline of 48% over the past five years. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

That being said, we compared Patanjali Foods' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 17% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Patanjali Foods fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Patanjali Foods Making Efficient Use Of Its Profits?

When we piece together Patanjali Foods' low three-year median payout ratio of 22% (where it is retaining 78% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Only recently, Patanjali Foods stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 14% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 16%, over the same period.

Summary

On the whole, we feel that the performance shown by Patanjali Foods can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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. 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.