Declining Stock and Solid Fundamentals: Is The Market Wrong About Brightcom Group Limited (NSE:BCG)?

Brightcom Group (NSE:BCG) has had a rough three months with its share price down 36%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Brightcom Group's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Our analysis indicates that BCG is potentially undervalued!

How Do You 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 Brightcom Group is:

20% = ₹11b ÷ ₹53b (Based on the trailing twelve months to June 2022).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.20 in profit.

What Is The Relationship Between ROE And 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. 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.

Brightcom Group's Earnings Growth And 20% ROE

To begin with, Brightcom Group seems to have a respectable ROE. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. This probably laid the ground for Brightcom Group's significant 24% 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. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Brightcom Group's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.0%.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Brightcom Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Brightcom Group Using Its Retained Earnings Effectively?

Brightcom Group's ' three-year median payout ratio is on the lower side at 1.1% implying that it is retaining a higher percentage (99%) of its profits. So it looks like Brightcom Group is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, Brightcom Group 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.

Summary

In total, we are pretty happy with Brightcom Group's performance. 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 3 risks we have identified for Brightcom Group.

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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.