Are Strong Financial Prospects The Force That Is Driving The Momentum In Par Drugs and Chemicals Limited's NSE:PAR) Stock?

Most readers would already be aware that Par Drugs and Chemicals' (NSE:PAR) stock increased significantly by 33% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Par Drugs and Chemicals' 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 Par Drugs and Chemicals

How Do You Calculate Return On Equity?

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 Par Drugs and Chemicals is:

18% = ₹83m ÷ ₹457m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.18.

What Is The Relationship Between ROE And 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.

Par Drugs and Chemicals' Earnings Growth And 18% ROE

To start with, Par Drugs and Chemicals' ROE looks acceptable. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. This certainly adds some context to Par Drugs and Chemicals' exceptional 39% net income growth seen over the past five years. However, there could also be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Par Drugs and Chemicals' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 16%.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Par Drugs and Chemicals fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Par Drugs and Chemicals Making Efficient Use Of Its Profits?

Par Drugs and Chemicals' three-year median payout ratio to shareholders is 23%, which is quite low. This implies that the company is retaining 77% of its profits. So it looks like Par Drugs and Chemicals is reinvesting profits heavily to grow its business, which shows in its earnings growth.

While Par Drugs and Chemicals has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Summary

Overall, we are quite pleased with Par Drugs and Chemicals' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 3 risks we have identified for Par Drugs and Chemicals visit our risks dashboard for free.

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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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