Declining Stock and Solid Fundamentals: Is The Market Wrong About Tata Elxsi Limited (NSE:TATAELXSI)?

With its stock down 14% over the past three months, it is easy to disregard Tata Elxsi (NSE:TATAELXSI). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Tata Elxsi's 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. 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 Tata Elxsi

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Tata Elxsi is:

33% = ₹8.2b ÷ ₹25b (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 ₹0.33 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Tata Elxsi's Earnings Growth And 33% ROE

To begin with, Tata Elxsi has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. As a result, Tata Elxsi's exceptional 25% net income growth seen over the past five years, doesn't come as a surprise.

As a next step, we compared Tata Elxsi's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 25% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 Tata Elxsi is trading on a high P/E or a low P/E, relative to its industry.

Is Tata Elxsi Making Efficient Use Of Its Profits?

The three-year median payout ratio for Tata Elxsi is 50%, which is moderately low. The company is retaining the remaining 50%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Tata Elxsi is reinvesting its earnings efficiently.

Besides, Tata Elxsi has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 47%. Accordingly, forecasts suggest that Tata Elxsi's future ROE will be 31% which is again, similar to the current ROE.

Summary

Overall, we are quite pleased with Tata Elxsi's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.