Stock Analysis

The KCP Limited's (NSE:KCP) Has Performed Well But Fundamentals Look Varied: Is There A Clear Direction For The Stock?

NSEI:KCP
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Most readers would already know that KCP's (NSE:KCP) stock increased by 6.0% over the past three months. However, we decided to study the company's mixed-bag of fundamentals to assess what this could mean for future share prices, as stock prices tend to be aligned with a company's long-term financial performance. Particularly, we will be paying attention to KCP's ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for KCP

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 KCP is:

8.9% = ₹962m ÷ ₹11b (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.09.

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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

KCP's Earnings Growth And 8.9% ROE

As you can see, KCP's ROE looks pretty weak. A comparison with the industry shows that the company's ROE is pretty similar to the average industry ROE of 10.0%. Given the low ROE KCP's five year net income decline of 20% is not surprising.

However, when we compared KCP's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.7% in the same period. This is quite worrisome.

past-earnings-growth
NSEI:KCP Past Earnings Growth January 30th 2021

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about KCP's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is KCP Using Its Retained Earnings Effectively?

When we piece together KCP's low three-year median payout ratio of 14% (where it is retaining 86% 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. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, KCP 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.

Summary

Overall, we have mixed feelings about KCP. 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. 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 2 risks we have identified for KCP 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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