Is The Market Rewarding IOL Chemicals and Pharmaceuticals Limited (NSE:IOLCP) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

IOL Chemicals and Pharmaceuticals (NSE:IOLCP) has had a rough month with its share price down 12%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study IOL Chemicals and Pharmaceuticals' 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 IOL Chemicals and Pharmaceuticals

How Do You 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 IOL Chemicals and Pharmaceuticals is:

6.0% = ₹998m ÷ ₹17b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.06.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

IOL Chemicals and Pharmaceuticals' Earnings Growth And 6.0% ROE

It is quite clear that IOL Chemicals and Pharmaceuticals' ROE is rather low. Even compared to the average industry ROE of 13%, the company's ROE is quite dismal. For this reason, IOL Chemicals and Pharmaceuticals' five year net income decline of 29% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared IOL Chemicals and Pharmaceuticals' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 14% in the same 5-year period.

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. 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 IOL Chemicals and Pharmaceuticals is trading on a high P/E or a low P/E, relative to its industry.

Is IOL Chemicals and Pharmaceuticals Making Efficient Use Of Its Profits?

When we piece together IOL Chemicals and Pharmaceuticals' low three-year median payout ratio of 17% (where it is retaining 83% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Moreover, IOL Chemicals and Pharmaceuticals has been paying dividends for five years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 16%. However, IOL Chemicals and Pharmaceuticals' ROE is predicted to rise to 10% despite there being no anticipated change in its payout ratio.

Summary

Overall, we have mixed feelings about IOL Chemicals and Pharmaceuticals. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings 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.