Shankara Building Products Limited's (NSE:SHANKARA) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Shankara Building Products (NSE:SHANKARA) has had a great run on the share market with its stock up by a significant 6.1% over the last month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to Shankara Building Products' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Shankara Building Products

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 Shankara Building Products is:

1.0% = ₹48m ÷ ₹4.9b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.01 in profit.

What Is The Relationship Between ROE And 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. 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.

A Side By Side comparison of Shankara Building Products' Earnings Growth And 1.0% ROE

As you can see, Shankara Building Products' ROE looks pretty weak. Even compared to the average industry ROE of 8.3%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 27% seen by Shankara Building Products was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Shankara Building Products' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 27% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Shankara Building Products fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shankara Building Products Making Efficient Use Of Its Profits?

Shankara Building Products' low three-year median payout ratio of 10% (or a retention ratio of 90%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Additionally, Shankara Building Products has paid dividends over a period of four years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

Overall, we have mixed feelings about Shankara Building Products. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 3 risks we have identified for Shankara Building Products.

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