Torrent Pharmaceuticals Limited's (NSE:TORNTPHARM) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Torrent Pharmaceuticals' (NSE:TORNTPHARM) recent performance, when its stock has declined 4.3% over the past three months. 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 Torrent Pharmaceuticals' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Torrent Pharmaceuticals

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Torrent Pharmaceuticals is:

24% = ₹18b ÷ ₹75b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.24 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. 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.

Torrent Pharmaceuticals' Earnings Growth And 24% ROE

To begin with, Torrent Pharmaceuticals seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 12%. This certainly adds some context to Torrent Pharmaceuticals' decent 13% net income growth seen over the past five years.

As a next step, we compared Torrent Pharmaceuticals' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 13% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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 Torrent Pharmaceuticals is trading on a high P/E or a low P/E, relative to its industry.

Is Torrent Pharmaceuticals Using Its Retained Earnings Effectively?

Torrent Pharmaceuticals has a significant three-year median payout ratio of 59%, meaning that it is left with only 41% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Moreover, Torrent Pharmaceuticals 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 37% over the next three years. As a result, the expected drop in Torrent Pharmaceuticals' payout ratio explains the anticipated rise in the company's future ROE to 30%, over the same period.

Summary

In total, we are pretty happy with Torrent Pharmaceuticals' performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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. 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.