Are Rashtriya Chemicals and Fertilizers Limited's (NSE:RCF) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

It is hard to get excited after looking at Rashtriya Chemicals and Fertilizers' (NSE:RCF) recent performance, when its stock has declined 11% over the past month. 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 Rashtriya Chemicals and Fertilizers' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Rashtriya Chemicals and Fertilizers

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 Rashtriya Chemicals and Fertilizers is:

4.2% = ₹2.0b ÷ ₹46b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.04.

What Has ROE Got To Do With 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 Rashtriya Chemicals and Fertilizers' Earnings Growth And 4.2% ROE

As you can see, Rashtriya Chemicals and Fertilizers' ROE looks pretty weak. Not just that, even compared to the industry average of 10%, the company's ROE is entirely unremarkable. However, the moderate 11% net income growth seen by Rashtriya Chemicals and Fertilizers over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Rashtriya Chemicals and Fertilizers' reported growth was lower than the industry growth of 15% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Rashtriya Chemicals and Fertilizers''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Rashtriya Chemicals and Fertilizers Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 30% (implying that the company retains 70% of its profits), it seems that Rashtriya Chemicals and Fertilizers is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Besides, Rashtriya Chemicals and Fertilizers has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

In total, it does look like Rashtriya Chemicals and Fertilizers has some positive aspects to its business. 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. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Rashtriya Chemicals and Fertilizers.

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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.