Declining Stock and Solid Fundamentals: Is The Market Wrong About Dr. Lal PathLabs Limited (NSE:LALPATHLAB)?

Dr. Lal PathLabs (NSE:LALPATHLAB) has had a rough three months with its share price down 12%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Dr. Lal PathLabs' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Dr. Lal PathLabs

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 Dr. Lal PathLabs is:

21% = ₹4.2b ÷ ₹20b (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.21 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. 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. 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.

Dr. Lal PathLabs' Earnings Growth And 21% ROE

To start with, Dr. Lal PathLabs' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 12%. This probably laid the ground for Dr. Lal PathLabs' moderate 8.8% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Dr. Lal PathLabs' reported growth was lower than the industry growth of 23% over the last few years, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. 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. 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 Dr. Lal PathLabs is trading on a high P/E or a low P/E, relative to its industry.

Is Dr. Lal PathLabs Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 41% (implying that the company retains 59% of its profits), it seems that Dr. Lal PathLabs is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Besides, Dr. Lal PathLabs has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 41%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 22%.

Summary

In total, we are pretty happy with Dr. Lal PathLabs' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.