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

With its stock down 3.4% over the past three months, it is easy to disregard Alkem Laboratories (NSE:ALKEM). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Alkem Laboratories' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

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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 Alkem Laboratories is:

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

The 'return' is the profit over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.18.

Check out our latest analysis for Alkem Laboratories

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

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 13% the company's ROE looks pretty remarkable. This probably laid the ground for Alkem Laboratories' moderate 7.1% net income growth seen over the past five years.

We then compared Alkem Laboratories' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 12% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Alkem Laboratories fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Alkem Laboratories Making Efficient Use Of Its Profits?

Alkem Laboratories has a healthy combination of a moderate three-year median payout ratio of 26% (or a retention ratio of 74%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 26% of its profits over the next three years. Accordingly, forecasts suggest that Alkem Laboratories' future ROE will be 18% which is again, similar to the current ROE.

Summary

Overall, we are quite pleased with Alkem Laboratories' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.