Orient Abrasives Limited (NSE:ORIENTABRA) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Most readers would already be aware that Orient Abrasives' (NSE:ORIENTABRA) stock increased significantly by 7.8% over the past month. 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 Orient Abrasives' ROE in this article.

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.

Check out our latest analysis for Orient Abrasives

How Is ROE Calculated?

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 Orient Abrasives is:

7.4% = ₹171m ÷ ₹2.3b (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.07.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Orient Abrasives' Earnings Growth And 7.4% ROE

It is hard to argue that Orient Abrasives' ROE is much good in and of itself. An industry comparison shows that the company's ROE is not much different from the industry average of 7.5% either. Therefore, the low net income growth of 2.1% seen by Orient Abrasives over the past five years could probably be the result of it having a lower ROE.

Next, on comparing with the industry net income growth, we found that Orient Abrasives' reported growth was lower than the industry growth of 17% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. 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. Is Orient Abrasives fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Orient Abrasives Efficiently Re-investing Its Profits?

A low three-year median payout ratio of 18% (implying that the company retains the remaining 82% of its income) suggests that Orient Abrasives is retaining most of its profits. However, the low earnings growth number doesn't reflect this as high growth usually follows high profit retention. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Orient Abrasives 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

In total, we're a bit ambivalent about Orient Abrasives' performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its 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. You can see the 2 risks we have identified for Orient Abrasives by visiting our risks dashboard for free on our platform here.

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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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