Has Supreme Petrochem Limited's (NSE:SUPPETRO) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Most readers would already be aware that Supreme Petrochem's (NSE:SUPPETRO) stock increased significantly by 69% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Supreme Petrochem's ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Supreme Petrochem

How To Calculate Return On Equity?

Return on equity 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 Supreme Petrochem is:

15% = ₹999m ÷ ₹6.9b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.15 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Supreme Petrochem's Earnings Growth And 15% ROE

At first glance, Supreme Petrochem's ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 11% doesn't go unnoticed by us. However, Supreme Petrochem's five year net income decline rate was 3.0%. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. So that could be one of the factors that are causing earnings growth to shrink.

However, when we compared Supreme Petrochem's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 15% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Supreme Petrochem's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Supreme Petrochem Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 34% (that is, a retention ratio of 66%), the fact that Supreme Petrochem's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Supreme Petrochem has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

Overall, we feel that Supreme Petrochem certainly does have some positive factors to consider. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 3 risks we have identified for Supreme Petrochem by visiting our risks dashboard for free on our platform here.

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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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