Shilpa Medicare Limited's (NSE:SHILPAMED) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Shilpa Medicare (NSE:SHILPAMED) has had a rough three months with its share price down 18%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Shilpa Medicare's ROE today.

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.

See our latest analysis for Shilpa Medicare

How Do You Calculate Return On Equity?

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 Shilpa Medicare is:

12% = ₹1.7b ÷ ₹15b (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.12 in profit.

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. 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. 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 Shilpa Medicare's Earnings Growth And 12% ROE

When you first look at it, Shilpa Medicare's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 14%, so we won't completely dismiss the company. Even so, Shilpa Medicare has shown a fairly decent growth in its net income which grew at a rate of 13%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's 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.

Next, on comparing Shilpa Medicare's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 16% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Shilpa Medicare is trading on a high P/E or a low P/E, relative to its industry.

Is Shilpa Medicare Using Its Retained Earnings Effectively?

Shilpa Medicare has a low three-year median payout ratio of 5.5%, meaning that the company retains the remaining 94% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Additionally, Shilpa Medicare has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. 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 5.4%. As a result, Shilpa Medicare's ROE is not expected to change by much either, which we inferred from the analyst estimate of 10% for future ROE.

Conclusion

On the whole, we do feel that Shilpa Medicare has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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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