Is The Market Rewarding Aarti Industries Limited (NSE:AARTIIND) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

With its stock down 16% over the past month, it is easy to disregard Aarti Industries (NSE:AARTIIND). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to Aarti Industries' ROE today.

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.

Check out our latest analysis for Aarti Industries

How Is ROE Calculated?

Return on equity 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 Aarti Industries is:

9.1% = ₹4.8b ÷ ₹53b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.09 in profit.

Why Is ROE Important For 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. 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.

A Side By Side comparison of Aarti Industries' Earnings Growth And 9.1% ROE

On the face of it, Aarti Industries' ROE is not much to talk about. However, its ROE is similar to the industry average of 11%, so we won't completely dismiss the company. However, Aarti Industries has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that Aarti Industries' reported growth was lower than the industry growth of 15% over the last few years, which is not something we like to see.

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). This then helps them determine if the stock is placed for a bright or bleak future. 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 Aarti Industries is trading on a high P/E or a low P/E, relative to its industry.

Is Aarti Industries Making Efficient Use Of Its Profits?

Aarti Industries has a low three-year median payout ratio of 12% (or a retention ratio of 88%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.

Moreover, Aarti Industries has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. 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 11%. Still, forecasts suggest that Aarti Industries' future ROE will rise to 14% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, we're a bit ambivalent about Aarti Industries' performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.