Is The Market Rewarding Ambuja Cements Limited (NSE:AMBUJACEM) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

With its stock down 8.6% over the past month, it is easy to disregard Ambuja Cements (NSE:AMBUJACEM). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study Ambuja Cements' ROE in this article.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Ambuja Cements

How To 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 Ambuja Cements is:

8.6% = ₹44b ÷ ₹508b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.09.

What Has ROE Got To Do With 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 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.

A Side By Side comparison of Ambuja Cements' Earnings Growth And 8.6% ROE

As you can see, Ambuja Cements' ROE looks pretty weak. A comparison with the industry shows that the company's ROE is pretty similar to the average industry ROE of 7.7%. Accordingly, Ambuja Cements' low net income growth of 5.0% over the past five years can possibly be explained by the low ROE amongst other factors.

Next, on comparing with the industry net income growth, we found that Ambuja Cements' reported growth was lower than the industry growth of 6.4% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Ambuja Cements fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Ambuja Cements Using Its Retained Earnings Effectively?

Ambuja Cements has a low three-year median payout ratio of 16% (meaning, the company keeps the remaining 84% of profits) which means that the company is retaining more of its earnings. However, the low earnings growth number doesn't reflect this fact. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Ambuja Cements has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 21% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Summary

On the whole, we feel that the performance shown by Ambuja Cements can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.