Most readers would already be aware that Tata Elxsi's (NSE:TATAELXSI) stock increased significantly by 47% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Tata Elxsi'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Is ROE Calculated?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Tata Elxsi is:
30% = ₹3.4b ÷ ₹11b (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.30 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. 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. 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.
Tata Elxsi's Earnings Growth And 30% ROE
Firstly, we acknowledge that Tata Elxsi has a significantly high ROE. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. This likely paved the way for the modest 14% net income growth seen by Tata Elxsi over the past five years. growth
Next, on comparing Tata Elxsi's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 13% in the same period.
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. 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 Efficiently Re-investing Its Profits?
Tata Elxsi has a three-year median payout ratio of 29%, which implies that it retains the remaining 71% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.
Additionally, Tata Elxsi has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.
In total, we are pretty happy with Tata Elxsi's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. To know the 2 risks we have identified for Tata Elxsi visit our risks dashboard for free.
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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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