Are Strong Financial Prospects The Force That Is Driving The Momentum In Varun Beverages Limited's NSE:VBL) Stock?

Varun Beverages (NSE:VBL) has had a great run on the share market with its stock up by a significant 8.5% over the last month. 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. Particularly, we will be paying attention to Varun Beverages' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Varun Beverages

How Do You 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 Varun Beverages is:

30% = ₹26b ÷ ₹87b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.30 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

A Side By Side comparison of Varun Beverages' Earnings Growth And 30% ROE

To begin with, Varun Beverages has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. Under the circumstances, Varun Beverages' considerable five year net income growth of 42% was to be expected.

As a next step, we compared Varun Beverages' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 25%.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Varun Beverages is trading on a high P/E or a low P/E, relative to its industry.

Is Varun Beverages Using Its Retained Earnings Effectively?

Varun Beverages' ' three-year median payout ratio is on the lower side at 14% implying that it is retaining a higher percentage (86%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Additionally, Varun Beverages has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 17% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

Overall, we are quite pleased with Varun Beverages' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.