Should Weakness in Bharat Rasayan Limited's (NSE:BHARATRAS) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 12% over the past week, it is easy to disregard Bharat Rasayan (NSE:BHARATRAS). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Bharat Rasayan's ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Bharat Rasayan

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 Bharat Rasayan is:

13% = ₹1.3b ÷ ₹9.9b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.13 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Bharat Rasayan's Earnings Growth And 13% ROE

When you first look at it, Bharat Rasayan's ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 11% which we definitely can't overlook. But seeing Bharat Rasayan's five year net income decline of 7.9% over the past five years, we might rethink that. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. Hence, this goes some way in explaining the shrinking earnings.

However, when we compared Bharat Rasayan's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 15% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Bharat Rasayan is trading on a high P/E or a low P/E, relative to its industry.

Is Bharat Rasayan Making Efficient Use Of Its Profits?

When we piece together Bharat Rasayan's low three-year median payout ratio of 0.5% (where it is retaining 99% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Moreover, Bharat Rasayan 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.

Summary

In total, it does look like Bharat Rasayan has some positive aspects to its business. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 2 risks we have identified for Bharat Rasayan by visiting our risks dashboard for free on our platform here.

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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.