Should Weakness in India Pesticides Limited's (NSE:IPL) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

India Pesticides (NSE:IPL) has had a rough month with its share price down 40%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on India Pesticides' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for India Pesticides

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 India Pesticides is:

11% = ₹900m ÷ ₹8.0b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.11.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

India Pesticides' Earnings Growth And 11% ROE

On the face of it, India Pesticides' ROE is not much to talk about. However, its ROE is similar to the industry average of 12%, so we won't completely dismiss the company. Even so, India Pesticides has shown a fairly decent growth in its net income which grew at a rate of 8.8%. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that India Pesticides' reported growth was lower than the industry growth of 17% over the last few years, which is not something we like to see.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is India Pesticides fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is India Pesticides Making Efficient Use Of Its Profits?

India Pesticides has a low three-year median payout ratio of 2.7%, meaning that the company retains the remaining 97% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

While India Pesticides has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 5.1% over the next three years. Regardless, the future ROE for India Pesticides is speculated to rise to 14% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Summary

On the whole, we do feel that India Pesticides has some positive attributes. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. 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.