It is hard to get excited after looking at Chambal Fertilisers and Chemicals' (NSE:CHAMBLFERT) recent performance, when its stock has declined 14% over the past month. 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. In this article, we decided to focus on Chambal Fertilisers and Chemicals' ROE.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Chambal Fertilisers and Chemicals is:
31% = ₹19b ÷ ₹59b (Based on the trailing twelve months to December 2021).
The 'return' refers to a company's earnings over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.31 in profit.
What Is The Relationship Between ROE And 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.
Chambal Fertilisers and Chemicals' Earnings Growth And 31% ROE
First thing first, we like that Chambal Fertilisers and Chemicals has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 16% which is quite remarkable. Under the circumstances, Chambal Fertilisers and Chemicals' considerable five year net income growth of 31% was to be expected.
We then compared Chambal Fertilisers and Chemicals' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 21% 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. 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 Chambal Fertilisers and Chemicals is trading on a high P/E or a low P/E, relative to its industry.
Is Chambal Fertilisers and Chemicals Using Its Retained Earnings Effectively?
Chambal Fertilisers and Chemicals' ' three-year median payout ratio is on the lower side at 16% implying that it is retaining a higher percentage (84%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Additionally, Chambal Fertilisers and Chemicals has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 25% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 20%, over the same period.
Overall, we are quite pleased with Chambal Fertilisers and Chemicals' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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.