Welspun (NSE:WELCORP) has had a great run on the share market with its stock up by a significant 11% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Welspun's ROE in this article.
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.
How Is ROE Calculated?
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 Welspun is:
17% = ₹5.7b ÷ ₹34b (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.17 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Welspun's Earnings Growth And 17% ROE
To begin with, Welspun seems to have a respectable ROE. Especially when compared to the industry average of 8.1% the company's ROE looks pretty impressive. This certainly adds some context to Welspun's exceptional 33% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Welspun's growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Welspun's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Welspun Making Efficient Use Of Its Profits?
Welspun's three-year median payout ratio to shareholders is 7.3%, which is quite low. This implies that the company is retaining 93% of its profits. So it looks like Welspun is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Moreover, Welspun is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 28% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.
On the whole, we feel that Welspun's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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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