Are Tatva Chintan Pharma Chem Limited's (NSE:TATVA) Mixed Financials The Reason For Its Gloomy Performance on The Stock Market?

With its stock down 25% over the past three months, it is easy to disregard Tatva Chintan Pharma Chem (NSE:TATVA). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to Tatva Chintan Pharma Chem's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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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:

1.9% = ₹143m ÷ ₹7.4b (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.02 in profit.

View our latest analysis for Tatva Chintan Pharma Chem

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Tatva Chintan Pharma Chem's Earnings Growth And 1.9% ROE

It is hard to argue that Tatva Chintan Pharma Chem's ROE is much good in and of itself. Even compared to the average industry ROE of 10%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 24% seen by Tatva Chintan Pharma Chem over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

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 13% over the last few years.

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 Tatva Chintan Pharma Chem is trading on a high P/E or a low P/E , relative to its industry.

Is Tatva Chintan Pharma Chem Using Its Retained Earnings Effectively?

Tatva Chintan Pharma Chem's low three-year median payout ratio of 9.7% (or a retention ratio of 90%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Additionally, Tatva Chintan Pharma Chem has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 16% over the next three years. Still, forecasts suggest that Tatva Chintan Pharma Chem's future ROE will rise to 8.5% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

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. 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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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.