Are Robust Financials Driving The Recent Rally In Radico Khaitan Limited's (NSE:RADICO) Stock?

Radico Khaitan (NSE:RADICO) has had a great run on the share market with its stock up by a significant 35% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Radico Khaitan's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Radico Khaitan

How To Calculate Return On Equity?

ROE 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 Radico Khaitan is:

15% = ₹2.3b ÷ ₹15b (Based on the trailing twelve months to March 2020).

The 'return' is the yearly profit. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.15 in profit.

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. 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. 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.

Radico Khaitan's Earnings Growth And 15% ROE

When you first look at it, Radico Khaitan's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 11% doesn't go unnoticed by us. Particularly, the substantial 29% net income growth seen by Radico Khaitan over the past five years is impressive . Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Therefore, the growth in earnings could also be the result of other factors. E.g the company has a low payout ratio or could belong to a high growth industry.

Next, on comparing Radico Khaitan's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 28% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Radico Khaitan's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Radico Khaitan Efficiently Re-investing Its Profits?

Radico Khaitan has a really low three-year median payout ratio of 11%, meaning that it has the remaining 89% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Moreover, Radico Khaitan is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

Overall, we are quite pleased with Radico Khaitan's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard will have the 1 risk we have identified for Radico Khaitan.

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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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