Sirca Paints India Limited's (NSE:SIRCA) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Sirca Paints India's (NSE:SIRCA) recent performance, when its stock has declined 19% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Sirca Paints India's ROE in this article.

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. 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 Sirca Paints India

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 Sirca Paints India is:

14% = ₹465m ÷ ₹3.2b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.14 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Sirca Paints India's Earnings Growth And 14% ROE

When you first look at it, Sirca Paints India's ROE doesn't look that attractive. Although a closer study shows that the company's ROE is higher than the industry average of 4.5% which we definitely can't overlook. Especially when you consider Sirca Paints India's exceptional 22% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Therefore, the growth in earnings could also be the result of other factors. Such as- high earnings retention or the company belonging to a high growth industry.

As a next step, we compared Sirca Paints India's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 30% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Sirca Paints India is trading on a high P/E or a low P/E, relative to its industry.

Is Sirca Paints India Using Its Retained Earnings Effectively?

Sirca Paints India's three-year median payout ratio to shareholders is 18%, which is quite low. This implies that the company is retaining 82% of its profits. So it looks like Sirca Paints India is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, Sirca Paints India is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 9.9% over the next three years. As a result, the expected drop in Sirca Paints India's payout ratio explains the anticipated rise in the company's future ROE to 19%, over the same period.

Conclusion

On the whole, we do feel that Sirca Paints India has some positive attributes. In particular, it's great to see that the company is investing heavily into its business and along with a moderate rate of return, that has resulted in a respectable growth in its earnings. 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.