Does The Market Have A Low Tolerance For Granules India Limited's (NSE:GRANULES) Mixed Fundamentals?

With its stock down 18% over the past month, it is easy to disregard Granules India (NSE:GRANULES). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to Granules India's ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Granules India

How To Calculate Return On Equity?

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 Granules India is:

14% = ₹4.8b ÷ ₹34b (Based on the trailing twelve months to December 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.14 in profit.

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.

Granules India's Earnings Growth And 14% ROE

At first glance, Granules India'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. Having said that, Granules India has shown a meagre net income growth of 2.7% over the past five years. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.

Next, on comparing with the industry net income growth, we found that Granules India's reported growth was lower than the industry growth of 13% over the last few years, which is not something we like to see.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Granules India's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Granules India Efficiently Re-investing Its Profits?

A low three-year median payout ratio of 8.0% (implying that the company retains the remaining 92% of its income) suggests that Granules India is retaining most of its profits. However, the low earnings growth number doesn't reflect this fact. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Granules India has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 4.5% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

On the whole, we feel that the performance shown by Granules India can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.