I G Petrochemicals Limited (NSE:IGPL) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

I G Petrochemicals' (NSE:IGPL) stock is up by a considerable 26% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study I G Petrochemicals' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for I G Petrochemicals

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 I G Petrochemicals is:

5.2% = ₹338m ÷ ₹6.6b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.05 in profit.

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 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 I G Petrochemicals' Earnings Growth And 5.2% ROE

It is quite clear that I G Petrochemicals' ROE is rather low. Even when compared to the industry average of 12%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 9.2% seen by I G Petrochemicals was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared I G Petrochemicals' 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 15% in the same period.

Earnings growth is a huge factor in stock valuation. 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. 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 I G Petrochemicals is trading on a high P/E or a low P/E, relative to its industry.

Is I G Petrochemicals Using Its Retained Earnings Effectively?

When we piece together I G Petrochemicals' low three-year median payout ratio of 11% (where it is retaining 89% 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, I G Petrochemicals has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.

Summary

On the whole, we feel that the performance shown by I G Petrochemicals can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 3 risks we have identified for I G Petrochemicals visit our risks dashboard for free.

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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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