Declining Stock and Decent Financials: Is The Market Wrong About Gujarat Gas Limited (NSE:GUJGASLTD)?

With its stock down 9.5% over the past three months, it is easy to disregard Gujarat Gas (NSE:GUJGASLTD). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Gujarat Gas' ROE.

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.

See our latest analysis for Gujarat Gas

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Gujarat Gas is:

16% = ₹13b ÷ ₹80b (Based on the trailing twelve months to September 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 ₹0.16 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Gujarat Gas' Earnings Growth And 16% ROE

To start with, Gujarat Gas' ROE looks acceptable. Even when compared to the industry average of 16% the company's ROE looks quite decent. Despite the moderate return on equity, Gujarat Gas has posted a net income growth of 3.1% over the past five years. So, there could be some other factors at play that could be impacting the company's growth. For instance, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Gujarat Gas' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 9.3% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Gujarat Gas''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Gujarat Gas Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 30% (or a retention ratio of 70% over the past three years, Gujarat Gas has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Gujarat Gas has been paying dividends over a period of nine years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 30% of its profits over the next three years. Accordingly, forecasts suggest that Gujarat Gas' future ROE will be 17% which is again, similar to the current ROE.

Conclusion

Overall, we feel that Gujarat Gas certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.