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 3.2% over the past week. 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.

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.

Our analysis indicates that ATGL is potentially overvalued!

How To 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:

19% = ₹5.1b ÷ ₹27b (Based on the trailing twelve months to September 2022).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.19 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. 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 19% ROE

To start with, Adani Total Gas' ROE looks acceptable. Further, the company's ROE is similar to the industry average of 20%. This probably goes some way in explaining Adani Total Gas' significant 23% net income growth over the past five years amongst other factors. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Adani Total Gas' growth is quite high when compared to the industry average growth of 19% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Adani Total Gas''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Adani Total Gas Using Its Retained Earnings Effectively?

Adani Total Gas' three-year median payout ratio to shareholders is 5.9%, which is quite low. This implies that the company is retaining 94% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

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

Conclusion

Overall, we are quite pleased with Adani Total Gas' 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. You can see the 3 risks we have identified for Adani Total Gas 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. 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.