Declining Stock and Solid Fundamentals: Is The Market Wrong About Asian Paints Limited (NSE:ASIANPAINT)?

It is hard to get excited after looking at Asian Paints' (NSE:ASIANPAINT) recent performance, when its stock has declined 9.8% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Asian Paints' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Asian Paints

How To 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 Asian Paints is:

24% = ₹31b ÷ ₹129b (Based on the trailing twelve months to December 2021).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.24 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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Asian Paints' Earnings Growth And 24% ROE

To begin with, Asian Paints seems to have a respectable ROE. Especially when compared to the industry average of 16% the company's ROE looks pretty impressive. Probably as a result of this, Asian Paints was able to see a decent growth of 12% over the last five years.

We then compared Asian Paints' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 21% in the same period, which is a bit concerning.

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). 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 Asian Paints is trading on a high P/E or a low P/E, relative to its industry.

Is Asian Paints Making Efficient Use Of Its Profits?

Asian Paints has a three-year median payout ratio of 49%, which implies that it retains the remaining 51% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Besides, Asian Paints has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 53%. However, Asian Paints' ROE is predicted to rise to 33% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we feel that Asian Paints' performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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. 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.