Has Rashtriya Chemicals and Fertilizers Limited's (NSE:RCF) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Rashtriya Chemicals and Fertilizers (NSE:RCF) has had a great run on the share market with its stock up by a significant 39% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Rashtriya Chemicals and Fertilizers' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Rashtriya Chemicals and Fertilizers

How To Calculate Return On Equity?

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:

11% = ₹5.2b ÷ ₹47b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.11 in profit.

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. 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.

Rashtriya Chemicals and Fertilizers' Earnings Growth And 11% ROE

On the face of it, Rashtriya Chemicals and Fertilizers' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 11%. Particularly, the exceptional 39% net income growth seen by Rashtriya Chemicals and Fertilizers over the past five years is pretty remarkable. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. 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' growth is quite high when compared to the industry average growth of 17% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Rashtriya Chemicals and Fertilizers is trading on a high P/E or a low P/E, relative to its industry.

Is Rashtriya Chemicals and Fertilizers Efficiently Re-investing Its Profits?

The three-year median payout ratio for Rashtriya Chemicals and Fertilizers is 30%, which is moderately low. The company is retaining the remaining 70%. So it seems that Rashtriya Chemicals and Fertilizers is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) 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

On the whole, we do feel that Rashtriya Chemicals and Fertilizers has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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.