South West Pinnacle Exploration Limited's (NSE:SOUTHWEST) Financials Are Too Obscure To Link With Current Share Price Momentum: What's In Store For the Stock?

South West Pinnacle Exploration (NSE:SOUTHWEST) has had a great run on the share market with its stock up by a significant 53% over the last three months. 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 South West Pinnacle Exploration'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for South West Pinnacle Exploration

How To Calculate Return On Equity?

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 South West Pinnacle Exploration is:

8.7% = ₹78m ÷ ₹888m (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.09 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. 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 South West Pinnacle Exploration's Earnings Growth And 8.7% ROE

As you can see, South West Pinnacle Exploration's ROE looks pretty weak. Further, we noted that the company's ROE is similar to the industry average of 8.1%. Thus, the low ROE provides some context to South West Pinnacle Exploration's flat net income growth over the past five years.

Next, on comparing with the industry net income growth, we found that South West Pinnacle Exploration's reported growth was lower than the industry growth of 12% in the same period, which is not something we like 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 South West Pinnacle Exploration is trading on a high P/E or a low P/E, relative to its industry.

Is South West Pinnacle Exploration Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 43% (or a retention ratio of 57%), South West Pinnacle Exploration hasn't seen much growth in its earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Conclusion

On the whole, we feel that the performance shown by South West Pinnacle Exploration can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of South West Pinnacle Exploration's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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This article by Simply Wall St is general in nature. 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.
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