Castrol India Limited's (NSE:CASTROLIND) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Castrol India (NSE:CASTROLIND) has had a rough three months with its share price down 25%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Castrol India's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Castrol India

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 Castrol India is:

42% = ₹9.0b ÷ ₹21b (Based on the trailing twelve months to September 2024).

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 ₹0.42.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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 Castrol India's Earnings Growth And 42% ROE

First thing first, we like that Castrol India has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 10% also doesn't go unnoticed by us. Despite this, Castrol India's five year net income growth was quite low averaging at only 4.6%. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Castrol India's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 15% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about Castrol India's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Castrol India Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 79% (that is, the company retains only 21% of its income) over the past three years for Castrol India suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Additionally, Castrol India 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 83% of its profits over the next three years. Accordingly, forecasts suggest that Castrol India's future ROE will be 44% which is again, similar to the current ROE.

Conclusion

Overall, we feel that Castrol India certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.