Declining Stock and Decent Financials: Is The Market Wrong About Ramkrishna Forgings Limited (NSE:RKFORGE)?

Ramkrishna Forgings (NSE:RKFORGE) has had a rough three months with its share price down 20%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Ramkrishna Forgings' 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. 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 Ramkrishna Forgings

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 Ramkrishna Forgings is:

13% = ₹3.9b ÷ ₹29b (Based on the trailing twelve months to December 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.13 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. 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.

Ramkrishna Forgings' Earnings Growth And 13% ROE

When you first look at it, Ramkrishna Forgings' ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 11%. Looking at Ramkrishna Forgings' exceptional 47% five-year net income growth in particular, we are definitely impressed. 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.

We then compared Ramkrishna Forgings' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 27% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Ramkrishna Forgings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Ramkrishna Forgings Using Its Retained Earnings Effectively?

Ramkrishna Forgings has a really low three-year median payout ratio of 9.0%, meaning that it has the remaining 91% left over to reinvest into its business. So it looks like Ramkrishna Forgings is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Ramkrishna Forgings has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 11% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Summary

In total, it does look like Ramkrishna Forgings has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.