Strides Pharma Science (NSE:STAR) has had a rough month with its share price down 8.1%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Strides Pharma Science's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Strides Pharma Science is:
8.7% = ₹2.4b ÷ ₹28b (Based on the trailing twelve months to March 2021).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.09.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Strides Pharma Science's Earnings Growth And 8.7% ROE
It is quite clear that Strides Pharma Science's ROE is rather low. Even when compared to the industry average of 15%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 14% seen by Strides Pharma Science was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
So, as a next step, we compared Strides Pharma Science's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a 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. 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. If you're wondering about Strides Pharma Science's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Strides Pharma Science Using Its Retained Earnings Effectively?
Looking at its three-year median payout ratio of 33% (or a retention ratio of 67%) which is pretty normal, Strides Pharma Science's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Moreover, Strides Pharma Science has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 9.8% over the next three years. As a result, the expected drop in Strides Pharma Science's payout ratio explains the anticipated rise in the company's future ROE to 13%, over the same period.
In total, we're a bit ambivalent about Strides Pharma Science's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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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