Stock Analysis

Could The Market Be Wrong About Tata Steel Limited (NSE:TATASTEEL) Given Its Attractive Financial Prospects?

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NSEI:TATASTEEL
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It is hard to get excited after looking at Tata Steel's (NSE:TATASTEEL) recent performance, when its stock has declined 2.1% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Tata Steel'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Tata Steel

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 Tata Steel is:

15% = ₹163b ÷ ₹1.1t (Based on the trailing twelve months to December 2022).

The 'return' is the yearly profit. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.15.

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. 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.

A Side By Side comparison of Tata Steel's Earnings Growth And 15% ROE

To start with, Tata Steel's ROE looks acceptable. Even when compared to the industry average of 14% the company's ROE looks quite decent. This probably goes some way in explaining Tata Steel's significant 29% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Tata Steel's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 24% in the same period.

past-earnings-growth
NSEI:TATASTEEL Past Earnings Growth March 16th 2023

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Tata Steel's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Tata Steel Making Efficient Use Of Its Profits?

Tata Steel has a three-year median payout ratio of 39% (where it is retaining 61% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Tata Steel is reinvesting its earnings efficiently.

Additionally, Tata Steel has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 22% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

Overall, we are quite pleased with Tata Steel's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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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