Has Divi's Laboratories Limited's (NSE:DIVISLAB) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Divi's Laboratories (NSE:DIVISLAB) has had a great run on the share market with its stock up by a significant 22% over the last 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 test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Divi's Laboratories

How To Calculate Return On Equity?

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 Divi's Laboratories is:

14% = ₹18b ÷ ₹128b (Based on the trailing twelve months to March 2023).

The 'return' is the profit over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.14 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Divi's Laboratories' Earnings Growth And 14% ROE

On the face of it, Divi's Laboratories' ROE is not much to talk about. However, its ROE is similar to the industry average of 13%, so we won't completely dismiss the company. Looking at Divi's Laboratories' exceptional 20% five-year net income growth in particular, we are definitely impressed. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Divi's Laboratories' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 20% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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?

Divi's Laboratories has a three-year median payout ratio of 27% (where it is retaining 73% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Divi's Laboratories is reinvesting its earnings efficiently.

Besides, Divi's Laboratories has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 29% of its profits over the next three years. Still, forecasts suggest that Divi's Laboratories' future ROE will rise to 19% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we do feel that Divi's Laboratories has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.