Castrol India's (NSE:CASTROLIND) stock is up by a considerable 6.1% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Castrol India's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
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:
51% = ₹7.8b ÷ ₹15b (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.51 in profit.
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 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 Castrol India's Earnings Growth And 51% 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 16% also doesn't go unnoticed by us. Despite this, Castrol India's five year net income growth was quite flat over the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital
Next, on comparing with the industry net income growth, we found that Castrol India's reported growth was lower than the industry growth of 18% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Castrol India fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Castrol India Making Efficient Use Of Its Profits?
Castrol India has a high three-year median payout ratio of 70% (or a retention ratio of 30%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.
Moreover, Castrol India 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.
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. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Castrol India and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.
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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.
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