Is Godrej Consumer Products Limited's (NSE:GODREJCP) Latest Stock Performance A Reflection Of Its Financial Health?

Godrej Consumer Products' (NSE:GODREJCP) stock is up by a considerable 14% 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 Godrej Consumer Products' ROE.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Godrej Consumer Products

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 Godrej Consumer Products is:

18% = ₹15b ÷ ₹87b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.18.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Godrej Consumer Products' Earnings Growth And 18% ROE

To begin with, Godrej Consumer Products seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 18%. This certainly adds some context to Godrej Consumer Products' moderate 13% net income growth seen over the past five years.

As a next step, we compared Godrej Consumer Products' 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 7.6%.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 Godrej Consumer Products is trading on a high P/E or a low P/E, relative to its industry.

Is Godrej Consumer Products Using Its Retained Earnings Effectively?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.

Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 56% over the next three years. However, Godrej Consumer Products' future ROE is expected to rise to 21% 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

In total, we are pretty happy with Godrej Consumer Products' 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. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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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