S H Kelkar and Company Limited (NSE:SHK) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

S H Kelkar (NSE:SHK) has had a great run on the share market with its stock up by a significant 11% over the last week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on S H Kelkar's 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for S H Kelkar

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for S H Kelkar is:

6.1% = ₹725m ÷ ₹12b (Based on the trailing twelve months to September 2023).

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 ₹0.06 in profit.

Why Is ROE Important For 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. 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.

A Side By Side comparison of S H Kelkar's Earnings Growth And 6.1% ROE

As you can see, S H Kelkar's ROE looks pretty weak. Even compared to the average industry ROE of 11%, the company's ROE is quite dismal. Thus, the low net income growth of 3.9% seen by S H Kelkar over the past five years could probably be the result of it having a lower ROE.

As a next step, we compared S H Kelkar's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 17% in the same period.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about S H Kelkar's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is S H Kelkar Using Its Retained Earnings Effectively?

S H Kelkar's low three-year median payout ratio of 12% (or a retention ratio of 88%) should mean that the company is retaining most of its earnings to fuel its growth. This should be reflected in its earnings growth number, but that's not the case. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, S H Kelkar has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we have mixed feelings about S H Kelkar. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard will have the 1 risk we have identified for S H Kelkar.

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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.