Divi's Laboratories Limited's (NSE:DIVISLAB) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Divi's Laboratories' (NSE:DIVISLAB) stock is up by a considerable 12% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Divi's 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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How Is ROE Calculated?

The formula for ROE 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% = ₹22b ÷ ₹150b (Based on the trailing twelve months to March 2025).

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 ₹0.15 in profit.

View our latest analysis for Divi's Laboratories

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.

Divi's Laboratories' Earnings Growth And 15% ROE

At first glance, Divi's Laboratories' ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 10% which we definitely can't overlook. Having said that, Divi's Laboratories' net income growth over the past five years is more or less flat. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the low to flat growth in earnings could also be the result of this.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 24% 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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Divi's Laboratories''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Divi's Laboratories Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 40% (or a retention ratio of 60%), Divi's Laboratories hasn't seen much growth in its earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Divi's Laboratories 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 28% over the next three years. The fact that the company's ROE is expected to rise to 19% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, we do feel that Divi's Laboratories has some positive attributes. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering 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.