Most readers would already be aware that Sreeleathers' (NSE:SREEL) stock increased significantly by 18% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Sreeleathers' ROE in this article.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Sreeleathers is:
5.4% = ₹175m ÷ ₹3.2b (Based on the trailing twelve months to December 2021).
The 'return' is the income the business earned over the last year. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.05.
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.
Sreeleathers' Earnings Growth And 5.4% ROE
It is quite clear that Sreeleathers' ROE is rather low. However, when compared to the industry average of 4.1%, we do feel there's definitely more to the company. But then again, seeing that Sreeleathers' five year net income shrunk at a rate of 2.1% in the past five years, makes us think again. Remember, the company's ROE is quite low to begin with, just that it is higher than the industry average. Therefore, the decline in earnings could also be the result of this.
However, when we compared Sreeleathers' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Sreeleathers''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Sreeleathers Using Its Retained Earnings Effectively?
Sreeleathers doesn't pay any dividend, meaning that potentially all of its profits are being reinvested in the business, which doesn't explain why the company's earnings have shrunk if it is retaining all of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
In total, it does look like Sreeleathers has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return and is reinvesting a huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Sreeleathers.
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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.