SRF's (NSE:SRF) stock is up by a considerable 27% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to SRF's ROE today.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To 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 SRF is:
14% = ₹12b ÷ ₹89b (Based on the trailing twelve months to March 2021).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.14 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
SRF's Earnings Growth And 14% ROE
On the face of it, SRF's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 13%, we may spare it some thought. Moreover, we are quite pleased to see that SRF's net income grew significantly at a rate of 22% over the last five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings 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.
As a next step, we compared SRF's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 15%.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is SRF fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is SRF Making Efficient Use Of Its Profits?
SRF has a really low three-year median payout ratio of 12%, meaning that it has the remaining 88% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Moreover, SRF is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 9.2% over the next three years. The fact that the company's ROE is expected to rise to 19% over the same period is explained by the drop in the payout ratio.
Overall, we feel that SRF certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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