Alkem Laboratories Limited's (NSE:ALKEM) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Alkem Laboratories (NSE:ALKEM) has had a rough three months with its share price down 11%. 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 Alkem Laboratories' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Alkem Laboratories

How Do You Calculate Return On Equity?

ROE 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 Alkem Laboratories is:

18% = ₹22b ÷ ₹119b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.18 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. 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.

Alkem Laboratories' Earnings Growth And 18% ROE

To begin with, Alkem Laboratories seems to have a respectable ROE. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. This certainly adds some context to Alkem Laboratories' decent 6.9% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Alkem Laboratories' reported growth was lower than the industry growth of 13% over the last few years, which is not something we like to see.

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

Is Alkem Laboratories Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 26% (implying that the company retains 74% of its profits), it seems that Alkem Laboratories is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Alkem Laboratories is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 26%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 19%.

Conclusion

Overall, we are quite pleased with Alkem Laboratories' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.