Tata Elxsi Limited's (NSE:TATAELXSI) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

Tata Elxsi's (NSE:TATAELXSI) stock is up by a considerable 44% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Tata Elxsi

How Do You 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 Tata Elxsi is:

27% = ₹3.1b ÷ ₹11b (Based on the trailing twelve months to September 2020).

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 ₹0.27 in profit.

What Has ROE Got To Do With 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 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 27% ROE

At first glance, Tata Elxsi seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. This certainly adds some context to Tata Elxsi's decent 15% net income growth seen over the past five years.

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 14% in the same period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Tata Elxsi's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Tata Elxsi Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 29% (implying that the company retains 71% of its profits), it seems that Tata Elxsi is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Tata Elxsi is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

On the whole, we feel that Tata Elxsi's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 2 risks we have identified for Tata Elxsi 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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