Piramal Pharma Limited (NSE:PPLPHARMA) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Piramal Pharma (NSE:PPLPHARMA) has had a great run on the share market with its stock up by a significant 42% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Piramal Pharma's ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Piramal Pharma

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 Piramal Pharma is:

0.6% = ₹453m ÷ ₹79b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.01 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. 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.

Piramal Pharma's Earnings Growth And 0.6% ROE

It is quite clear that Piramal Pharma's ROE is rather low. Not just that, even compared to the industry average of 12%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 105% seen by Piramal Pharma over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Piramal Pharma's 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 13% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Piramal Pharma fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Piramal Pharma Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 37% (that is, a retention ratio of 63%), the fact that Piramal Pharma's earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Only recently, Piramal Pharma stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 15% over the next three years. The fact that the company's ROE is expected to rise to 8.8% over the same period is explained by the drop in the payout ratio.

Conclusion

In total, we're a bit ambivalent about Piramal Pharma's performance. 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.