eClerx Services Limited's (NSE:ECLERX) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

By
Simply Wall St
Published
October 21, 2021
NSEI:ECLERX
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eClerx Services (NSE:ECLERX) has had a rough week with its share price down 11%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study eClerx Services' ROE in this article.

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.

See our latest analysis for eClerx Services

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 eClerx Services is:

22% = ₹3.2b ÷ ₹15b (Based on the trailing twelve months to June 2021).

The 'return' is the profit over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.22.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of eClerx Services' Earnings Growth And 22% ROE

To start with, eClerx Services' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 13%. Needless to say, we are quite surprised to see that eClerx Services' net income shrunk at a rate of 11% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.

That being said, we compared eClerx Services' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 12% in the same period.

past-earnings-growth
NSEI:ECLERX Past Earnings Growth October 22nd 2021

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 eClerx Services fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is eClerx Services Efficiently Re-investing Its Profits?

eClerx Services' low three-year median payout ratio of 1.7% (implying that it retains the remaining 98% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Additionally, eClerx Services has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 45% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Conclusion

On the whole, we do feel that eClerx Services has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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