Has Zydus Wellness Limited's (NSE:ZYDUSWELL) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Zydus Wellness (NSE:ZYDUSWELL) has had a great run on the share market with its stock up by a significant 18% over the last month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Zydus Wellness' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Zydus Wellness

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Zydus Wellness is:

1.3% = ₹572m ÷ ₹44b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.01.

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. 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. 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.

Zydus Wellness' Earnings Growth And 1.3% ROE

It is hard to argue that Zydus Wellness' ROE is much good in and of itself. Even compared to the average industry ROE of 10%, the company's ROE is quite dismal. Although, we can see that Zydus Wellness saw a modest net income growth of 7.2% over the past five years. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Zydus Wellness' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 19% in the same period, which is a bit concerning.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Zydus Wellness fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Zydus Wellness Using Its Retained Earnings Effectively?

Zydus Wellness' three-year median payout ratio to shareholders is 20% (implying that it retains 80% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Zydus Wellness 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 25% over the next three years. However, Zydus Wellness' future ROE is expected to rise to 8.0% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Conclusion

On the whole, we do feel that Zydus Wellness has some positive attributes. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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. 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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