Declining Stock and Solid Fundamentals: Is The Market Wrong About Adani Total Gas Limited (NSE:ATGL)?

It is hard to get excited after looking at Adani Total Gas' (NSE:ATGL) recent performance, when its stock has declined 14% over the past month. 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 Adani Total Gas' 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 Adani Total Gas

How Do You Calculate Return On Equity?

ROE 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 Adani Total Gas is:

17% = ₹6.7b ÷ ₹39b (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.17 in profit.

Why Is ROE Important For Earnings Growth?

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

Adani Total Gas' Earnings Growth And 17% ROE

To begin with, Adani Total Gas seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 16%. Consequently, this likely laid the ground for the decent growth of 10% seen over the past five years by Adani Total Gas.

As a next step, we compared Adani Total Gas' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.3%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Adani Total Gas is trading on a high P/E or a low P/E, relative to its industry.

Is Adani Total Gas Using Its Retained Earnings Effectively?

In Adani Total Gas' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 5.0% (or a retention ratio of 95%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Adani Total Gas is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend.

Summary

On the whole, we feel that Adani Total Gas' performance has been quite good. 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. 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. To know the 1 risk we have identified for Adani Total Gas visit our risks dashboard for free.

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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.