Is The Market Rewarding Aurobindo Pharma Limited (NSE:AUROPHARMA) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

Aurobindo Pharma (NSE:AUROPHARMA) has had a rough three months with its share price down 8.8%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Aurobindo Pharma's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Aurobindo Pharma

How Is ROE Calculated?

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 Aurobindo Pharma is:

11% = ₹35b ÷ ₹309b (Based on the trailing twelve months to December 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.11.

What Has ROE Got To Do With 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. 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.

Aurobindo Pharma's Earnings Growth And 11% ROE

At first glance, Aurobindo Pharma's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 13%, we may spare it some thought. But Aurobindo Pharma saw a five year net income decline of 5.8% over the past five years. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

However, when we compared Aurobindo Pharma's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 13% in the same period. This is quite worrisome.

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. What is AUROPHARMA worth today? The intrinsic value infographic in our free research report helps visualize whether AUROPHARMA is currently mispriced by the market.

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. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Additionally, Aurobindo Pharma has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 6.5% over the next three years. However, the company's ROE is not expected to change by much 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. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.