Is Dr. Reddy's Laboratories Limited's (NSE:DRREDDY) Latest Stock Performance A Reflection Of Its Financial Health?

Dr. Reddy's Laboratories (NSE:DRREDDY) has had a great run on the share market with its stock up by a significant 7.1% over the last month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Dr. Reddy's Laboratories' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Dr. Reddy's Laboratories

How Is ROE Calculated?

ROE 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 Dr. Reddy's Laboratories is:

18% = ₹54b ÷ ₹309b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.18 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. 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.

Dr. Reddy's Laboratories' Earnings Growth And 18% ROE

At first glance, Dr. Reddy's Laboratories seems to have a decent ROE. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. This certainly adds some context to Dr. Reddy's Laboratories' exceptional 27% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Dr. Reddy's Laboratories' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 13% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Dr. Reddy's Laboratories is trading on a high P/E or a low P/E, relative to its industry.

Is Dr. Reddy's Laboratories Efficiently Re-investing Its Profits?

Dr. Reddy's Laboratories has a really low three-year median payout ratio of 14%, meaning that it has the remaining 86% left over to reinvest into its business. So it looks like Dr. Reddy's Laboratories is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Dr. Reddy'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 16% of its profits over the next three years. Accordingly, forecasts suggest that Dr. Reddy's Laboratories' future ROE will be 15% which is again, similar to the current ROE.

Summary

Overall, we are quite pleased with Dr. Reddy's Laboratories' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.