Is Nelco Limited's (NSE:NELCO) Recent Stock Performance Tethered To Its Strong Fundamentals?

Most readers would already be aware that Nelco's (NSE:NELCO) stock increased significantly by 24% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Nelco's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Nelco

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 Nelco is:

18% = ₹225m ÷ ₹1.2b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.18 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Nelco's Earnings Growth And 18% ROE

To start with, Nelco's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 11%. This certainly adds some context to Nelco's decent 11% net income growth seen over the past five years.

We then compared Nelco's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 22% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. 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. Is Nelco fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Nelco Efficiently Re-investing Its Profits?

In Nelco's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 23% (or a retention ratio of 77%), which suggests that the company is investing most of its profits to grow its business.

Besides, Nelco has been paying dividends over a period of five years. This shows that the company is committed to sharing profits with its shareholders.

Summary

In total, we are pretty happy with Nelco's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising.

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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.