Declining Stock and Decent Financials: Is The Market Wrong About Divi's Laboratories Limited (NSE:DIVISLAB)?

Divi's Laboratories (NSE:DIVISLAB) has had a rough three months with its share price down 3.8%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Divi's Laboratories' ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Divi's Laboratories

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 Divi's Laboratories is:

15% = ₹21b ÷ ₹137b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.15 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. 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. 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.

A Side By Side comparison of Divi's Laboratories' Earnings Growth And 15% ROE

At first glance, Divi's Laboratories seems to have a decent ROE. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Given the circumstances, we can't help but wonder why Divi's Laboratories saw little to no growth in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Divi's Laboratories' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 25% in the same period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 Divi's Laboratories is trading on a high P/E or a low P/E, relative to its industry.

Is Divi's Laboratories Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 44% (implying that the company keeps 56% of its income) over the last three years, Divi's Laboratories has seen a negligible amount of growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Divi's Laboratories 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 31% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we feel that Divi's Laboratories certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.