Are Robust Financials Driving The Recent Rally In Aarti Drugs Limited's (NSE:AARTIDRUGS) Stock?

Most readers would already be aware that Aarti Drugs' (NSE:AARTIDRUGS) stock increased significantly by 147% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Aarti Drugs' ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Aarti Drugs

How To Calculate Return On Equity?

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 Aarti Drugs is:

31% = ₹2.0b ÷ ₹6.5b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax 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 ₹0.31 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. 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. 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.

Aarti Drugs' Earnings Growth And 31% ROE

To begin with, Aarti Drugs has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 12% also doesn't go unnoticed by us. This probably laid the groundwork for Aarti Drugs' moderate 15% net income growth seen over the past five years.

Next, on comparing Aarti Drugs' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 16% in the same period.

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. Is Aarti Drugs fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Aarti Drugs Using Its Retained Earnings Effectively?

Aarti Drugs' three-year median payout ratio to shareholders is 3.1% (implying that it retains 97% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Besides, Aarti Drugs has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 6.5% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 25%, over the same period.

Summary

On the whole, we feel that Aarti Drugs' 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. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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. 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.
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