Is RHI Magnesita India Limited's (NSE:RHIM) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

By
Simply Wall St
Published
August 18, 2021
NSEI:RHIM
Source: Shutterstock

Most readers would already be aware that RHI Magnesita India's (NSE:RHIM) stock increased significantly by 10% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on RHI Magnesita India's ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for RHI Magnesita India

How Do You 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 RHI Magnesita India is:

21% = ₹1.7b ÷ ₹8.1b (Based on the trailing twelve months to June 2021).

The 'return' is the profit over the last twelve months. 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. 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 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.

RHI Magnesita India's Earnings Growth And 21% ROE

At first glance, RHI Magnesita India seems to have a decent ROE. On comparing with the average industry ROE of 15% the company's ROE looks pretty remarkable. This probably laid the ground for RHI Magnesita India's moderate 12% net income growth seen over the past five years.

We then compared RHI Magnesita India's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 19% in the same period, which is a bit concerning.

past-earnings-growth
NSEI:RHIM Past Earnings Growth August 19th 2021

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 RHI Magnesita India is trading on a high P/E or a low P/E, relative to its industry.

Is RHI Magnesita India Using Its Retained Earnings Effectively?

RHI Magnesita India has a healthy combination of a moderate three-year median payout ratio of 33% (or a retention ratio of 67%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Moreover, RHI Magnesita India is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend.

Summary

In total, we are pretty happy with RHI Magnesita India's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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 2 risks we have identified for RHI Magnesita India.

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