Is Varun Beverages Limited's (NSE:VBL) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Varun Beverages' (NSE:VBL) stock is up by a considerable 20% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Varun Beverages' ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Varun Beverages

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 Varun Beverages is:

31% = ₹20b ÷ ₹66b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.31 in profit.

What Is The Relationship Between ROE And 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.

Varun Beverages' Earnings Growth And 31% ROE

To begin with, Varun Beverages has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 15% also doesn't go unnoticed by us. 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 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). 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 Varun Beverages''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Varun Beverages Making Efficient Use Of Its Profits?

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. So it looks like Varun Beverages is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, Varun Beverages has paid dividends over a period of six 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 18% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Conclusion

Overall, we are quite pleased with Varun Beverages' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.