Could The Market Be Wrong About Sreeleathers Limited (NSE:SREEL) Given Its Attractive Financial Prospects?

It is hard to get excited after looking at Sreeleathers' (NSE:SREEL) recent performance, when its stock has declined 11% over the past month. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Sreeleathers' ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Sreeleathers

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 Sreeleathers is:

6.4% = ₹207m ÷ ₹3.2b (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.06 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 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.

Sreeleathers' Earnings Growth And 6.4% ROE

As you can see, Sreeleathers' ROE looks pretty weak. However, when compared to the industry average of 4.0%, we do feel there's definitely more to the company. Even more so, after seeing Sreeleathers' exceptional 23% net income growth over the past five years. That being said, the company does have a low ROE to begin with, just that its higher than the industry average. Hence, there might be some other aspects that are causing earnings to grow. 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.

We then performed a comparison between Sreeleathers' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 25% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is SREEL worth today? The intrinsic value infographic in our free research report helps visualize whether SREEL is currently mispriced by the market.

Is Sreeleathers Making Efficient Use Of Its Profits?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. This is likely what's driving the high earnings growth number discussed above.

Summary

On the whole, we feel that Sreeleathers' performance has been quite good. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 1 risk we have identified for Sreeleathers by visiting our risks dashboard for free on our platform here.

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This article by Simply Wall St is general in nature. 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.
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