Does The Market Have A Low Tolerance For Alembic Pharmaceuticals Limited's (NSE:APLLTD) Mixed Fundamentals?

Alembic Pharmaceuticals (NSE:APLLTD) has had a rough three months with its share price down 19%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study Alembic Pharmaceuticals' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Alembic Pharmaceuticals

How Is ROE Calculated?

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 Alembic Pharmaceuticals is:

4.1% = ₹2.1b ÷ ₹51b (Based on the trailing twelve months to December 2022).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.04 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Alembic Pharmaceuticals' Earnings Growth And 4.1% ROE

It is hard to argue that Alembic Pharmaceuticals' ROE is much good in and of itself. Even compared to the average industry ROE of 12%, the company's ROE is quite dismal. Accordingly, Alembic Pharmaceuticals' low net income growth of 2.1% over the past five years can possibly be explained by the low ROE amongst other factors.

Next, on comparing with the industry net income growth, we found that Alembic Pharmaceuticals' reported growth was lower than the industry growth of 18% in the same period, 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. Has the market priced in the future outlook for APLLTD? You can find out in our latest intrinsic value infographic research report.

Is Alembic Pharmaceuticals Using Its Retained Earnings Effectively?

Alembic Pharmaceuticals' low three-year median payout ratio of 25% (or a retention ratio of 75%) should mean that the company is retaining most of its earnings to fuel its growth. However, the low earnings growth number doesn't reflect this as high growth usually follows high profit retention. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Alembic Pharmaceuticals has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 17% over the next three years. As a result, the expected drop in Alembic Pharmaceuticals' payout ratio explains the anticipated rise in the company's future ROE to 14%, over the same period.

Summary

Overall, we have mixed feelings about Alembic Pharmaceuticals. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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. 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.