Can Mixed Fundamentals Have A Negative Impact on Thirumalai Chemicals Limited (NSE:TIRUMALCHM) Current Share Price Momentum?

Thirumalai Chemicals (NSE:TIRUMALCHM) has had a great run on the share market with its stock up by a significant 9.7% over the last month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Thirumalai Chemicals' 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Thirumalai Chemicals

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 Thirumalai Chemicals is:

5.3% = ₹355m ÷ ₹6.7b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.05 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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 Thirumalai Chemicals' Earnings Growth And 5.3% ROE

It is hard to argue that Thirumalai Chemicals' ROE is much good in and of itself. Not just that, even compared to the industry average of 13%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 6.3% seen by Thirumalai Chemicals was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

So, as a next step, we compared Thirumalai Chemicals' 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 14% in the same period.

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 Thirumalai Chemicals is trading on a high P/E or a low P/E, relative to its industry.

Is Thirumalai Chemicals Using Its Retained Earnings Effectively?

While the company did payout a portion of its dividend in the past, it currently doesn't pay a dividend. This implies that potentially all of its profits are being reinvested in the business.

Conclusion

On the whole, we feel that the performance shown by Thirumalai Chemicals can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard will have the 1 risk we have identified for Thirumalai Chemicals.

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