Greenply Industries Limited (NSE:GREENPLY) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Greenply Industries (NSE:GREENPLY) has had a great run on the share market with its stock up by a significant 36% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Greenply Industries' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Greenply Industries

How Do You 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 Greenply Industries is:

1.9% = ₹71m ÷ ₹3.8b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.02 in profit.

What Has ROE Got To Do With 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.

Greenply Industries' Earnings Growth And 1.9% ROE

As you can see, Greenply Industries' ROE looks pretty weak. Not just that, even compared to the industry average of 8.2%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 26% seen by Greenply Industries was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared Greenply Industries' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 17% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Greenply Industries fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Greenply Industries Making Efficient Use Of Its Profits?

When we piece together Greenply Industries' low three-year median payout ratio of 10% (where it is retaining 90% 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.

In addition, Greenply Industries has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 9.4%. Regardless, the future ROE for Greenply Industries is predicted to rise to 20% despite there being not much change expected in its payout ratio.

Conclusion

In total, we're a bit ambivalent about Greenply Industries' 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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This article by Simply Wall St is general in nature. 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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