Bodal Chemicals' (NSE:BODALCHEM) stock is up by a considerable 32% over the past month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Bodal Chemicals' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Bodal Chemicals is:
4.8% = ₹445m ÷ ₹9.3b (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.05.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Bodal Chemicals' Earnings Growth And 4.8% ROE
As you can see, Bodal Chemicals' ROE looks pretty weak. Even compared to the average industry ROE of 13%, the company's ROE is quite dismal. For this reason, Bodal Chemicals' five year net income decline of 16% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
That being said, we compared Bodal Chemicals' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 14% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Bodal Chemicals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Bodal Chemicals Efficiently Re-investing Its Profits?
When we piece together Bodal Chemicals' low three-year median payout ratio of 7.5% (where it is retaining 93% 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 might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.
Additionally, Bodal Chemicals has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 5.0% over the next three years. As a result, the expected drop in Bodal Chemicals' payout ratio explains the anticipated rise in the company's future ROE to 10%, over the same period.
In total, we're a bit ambivalent about Bodal Chemicals' performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings 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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