Aurobindo Pharma Limited (NSE:AUROPHARMA) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Most readers would already be aware that Aurobindo Pharma's (NSE:AUROPHARMA) stock increased significantly by 22% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Aurobindo Pharma's ROE in this article.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Aurobindo Pharma

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Aurobindo Pharma is:

11% = ₹32b ÷ ₹299b (Based on the trailing twelve months to March 2024).

The 'return' is the profit 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 ₹0.11 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. 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 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.

Aurobindo Pharma's Earnings Growth And 11% ROE

On the face of it, Aurobindo Pharma's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 12%. But Aurobindo Pharma saw a five year net income decline of 4.6% over the past five years. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

So, as a next step, we compared Aurobindo Pharma's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 16% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Aurobindo Pharma is trading on a high P/E or a low P/E, relative to its industry.

Is Aurobindo Pharma Using Its Retained Earnings Effectively?

When we piece together Aurobindo Pharma's low three-year median payout ratio of 9.2% (where it is retaining 91% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Aurobindo Pharma 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 6.7% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Conclusion

On the whole, we feel that the performance shown by Aurobindo Pharma can be open to many interpretations. 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 industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.

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