Indraprastha Gas (NSE:IGL) has had a rough week with its share price down 5.5%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Indraprastha Gas' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You 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 Indraprastha Gas is:
22% = ₹14b ÷ ₹63b (Based on the trailing twelve months to June 2021).
The 'return' is the profit over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.22.
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 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.
A Side By Side comparison of Indraprastha Gas' Earnings Growth And 22% ROE
At first glance, Indraprastha Gas seems to have a decent ROE. Even when compared to the industry average of 27% the company's ROE looks quite decent. This certainly adds some context to Indraprastha Gas' moderate 16% net income growth seen over the past five years.
We then performed a comparison between Indraprastha Gas' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 19% in the same period.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for IGL? You can find out in our latest intrinsic value infographic research report.
Is Indraprastha Gas Using Its Retained Earnings Effectively?
Indraprastha Gas' three-year median payout ratio to shareholders is 20% (implying that it retains 80% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Additionally, Indraprastha Gas has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 15% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
Overall, we are quite pleased with Indraprastha Gas' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.
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