Are Tatva Chintan Pharma Chem Limited's (NSE:TATVA) Mixed Financials Driving The Negative Sentiment?

It is hard to get excited after looking at Tatva Chintan Pharma Chem's (NSE:TATVA) recent performance, when its stock has declined 20% over the past three months. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Tatva Chintan Pharma Chem'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Tatva Chintan Pharma Chem

How Is ROE Calculated?

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 Tatva Chintan Pharma Chem is:

3.5% = ₹261m ÷ ₹7.4b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.04 in profit.

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. 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 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 Tatva Chintan Pharma Chem's Earnings Growth And 3.5% ROE

As you can see, Tatva Chintan Pharma Chem's ROE looks pretty weak. Even compared to the average industry ROE of 10%, the company's ROE is quite dismal. For this reason, Tatva Chintan Pharma Chem's five year net income decline of 17% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Tatva Chintan Pharma Chem's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 16% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. 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. Is Tatva Chintan Pharma Chem fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Tatva Chintan Pharma Chem Making Efficient Use Of Its Profits?

Tatva Chintan Pharma Chem's low three-year median payout ratio of 9.7% (implying that it retains the remaining 90% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

In addition, Tatva Chintan Pharma Chem only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.

Summary

In total, we're a bit ambivalent about Tatva Chintan Pharma Chem's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com