Is GAIL (India) Limited's (NSE:GAIL) Recent Price Movement Underpinned By Its Weak Fundamentals?

It is hard to get excited after looking at GAIL (India)'s (NSE:GAIL) recent performance, when its stock has declined 6.6% over the past month. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to GAIL (India)'s ROE today.

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 GAIL (India)

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 GAIL (India) is:

13% = ₹99b ÷ ₹772b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.13 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. 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.

GAIL (India)'s Earnings Growth And 13% ROE

On the face of it, GAIL (India)'s ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 15%, we may spare it some thought. We can see that GAIL (India) has grown at a five year net income growth average rate of 3.0%, which is a bit on the lower side. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.

We then compared GAIL (India)'s net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 13% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 GAIL (India) is trading on a high P/E or a low P/E, relative to its industry.

Is GAIL (India) Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 36% (implying that the company retains the remaining 64% of its income), GAIL (India)'s earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, GAIL (India) has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 40%. As a result, GAIL (India)'s ROE is not expected to change by much either, which we inferred from the analyst estimate of 14% for future ROE.

Summary

In total, we're a bit ambivalent about GAIL (India)'s performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.