Most readers would already be aware that Rashtriya Chemicals and Fertilizers' (NSE:RCF) stock increased significantly by 33% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Rashtriya Chemicals and Fertilizers' ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Our analysis indicates that RCF is potentially undervalued!
How Is ROE Calculated?
Return on equity 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 Rashtriya Chemicals and Fertilizers is:
21% = ₹9.2b ÷ ₹44b (Based on the trailing twelve months to September 2022).
The 'return' is the yearly profit. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.21 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
A Side By Side comparison of Rashtriya Chemicals and Fertilizers' Earnings Growth And 21% ROE
To start with, Rashtriya Chemicals and Fertilizers' ROE looks acceptable. Especially when compared to the industry average of 15% the company's ROE looks pretty impressive. This probably laid the ground for Rashtriya Chemicals and Fertilizers' significant 52% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
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 22% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Rashtriya Chemicals and Fertilizers is reinvesting its earnings efficiently.
Moreover, Rashtriya Chemicals and Fertilizers is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.
In total, we are pretty happy with Rashtriya Chemicals and Fertilizers' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard would have the 3 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.