Ipca Laboratories Limited's (NSE:IPCALAB) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 15% over the past three months, it is easy to disregard Ipca Laboratories (NSE:IPCALAB). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Ipca Laboratories' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Ipca Laboratories

How Is ROE Calculated?

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 Ipca Laboratories is:

24% = ₹11b ÷ ₹44b (Based on the trailing twelve months to December 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.24 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Ipca Laboratories' Earnings Growth And 24% ROE

At first glance, Ipca Laboratories seems to have a decent ROE. On comparing with the average industry ROE of 15% the company's ROE looks pretty remarkable. Probably as a result of this, Ipca Laboratories was able to see an impressive net income growth of 35% over the last five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Ipca Laboratories' growth is quite high when compared to the industry average growth of 16% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 Ipca Laboratories is trading on a high P/E or a low P/E, relative to its industry.

Is Ipca Laboratories Making Efficient Use Of Its Profits?

Ipca Laboratories' ' three-year median payout ratio is on the lower side at 9.5% implying that it is retaining a higher percentage (91%) of its profits. So it looks like Ipca Laboratories is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, Ipca Laboratories is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 9.6%. As a result, Ipca Laboratories' ROE is not expected to change by much either, which we inferred from the analyst estimate of 21% for future ROE.

Summary

On the whole, we feel that Ipca Laboratories' performance has been quite good. 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, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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. 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.
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