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

Most readers would already be aware that Prakash Industries' (NSE:PRAKASH) stock increased significantly by 31% 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. In this article, we decided to focus on Prakash 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. 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 Prakash Industries

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Prakash Industries is:

12% = ₹3.5b ÷ ₹30b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.12.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Prakash Industries' Earnings Growth And 12% ROE

When you first look at it, Prakash Industries' ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 12%, we may spare it some thought. But then again, Prakash Industries' five year net income shrunk at a rate of 3.0%. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.

However, when we compared Prakash Industries' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 27% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Prakash Industries''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Prakash Industries Efficiently Re-investing Its Profits?

Prakash Industries' low three-year median payout ratio of 6.2% (implying that it retains the remaining 94% of its profits) comes as a surprise when you pair it with the shrinking earnings. 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.

Moreover, Prakash Industries has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

On the whole, we feel that the performance shown by Prakash Industries can be open to many interpretations. 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. Our risks dashboard would have the 3 risks we have identified for Prakash Industries.

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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.