Could The Market Be Wrong About Sarthak Metals Limited (NSE:SMLT) Given Its Attractive Financial Prospects?

By
Simply Wall St
Published
February 23, 2022
NSEI:SMLT
Source: Shutterstock

Sarthak Metals (NSE:SMLT) has had a rough week with its share price down 12%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Sarthak Metals' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Sarthak Metals

How Is ROE Calculated?

ROE 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 Sarthak Metals is:

35% = ₹223m ÷ ₹643m (Based on the trailing twelve months to December 2021).

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 ₹0.35 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Sarthak Metals' Earnings Growth And 35% ROE

To begin with, Sarthak Metals has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 16% the company's ROE is quite impressive. So, the substantial 34% net income growth seen by Sarthak Metals over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Sarthak Metals' growth is quite high when compared to the industry average growth of 19% in the same period, which is great to see.

past-earnings-growth
NSEI:SMLT Past Earnings Growth February 23rd 2022

Earnings growth is an important metric to consider when valuing a stock. 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. 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 Sarthak Metals is trading on a high P/E or a low P/E, relative to its industry.

Is Sarthak Metals Making Efficient Use Of Its Profits?

Sarthak Metals' three-year median payout ratio to shareholders is 13%, which is quite low. This implies that the company is retaining 87% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Sarthak Metals is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend.

Conclusion

Overall, we are quite pleased with Sarthak Metals' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 4 risks we have identified for Sarthak Metals by visiting our risks dashboard for free on our platform here.

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