Is Mahanagar Gas Limited's (NSE:MGL) Latest Stock Performance A Reflection Of Its Financial Health?

Most readers would already be aware that Mahanagar Gas' (NSE:MGL) stock increased significantly by 17% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Mahanagar Gas' ROE today.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Mahanagar 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 Mahanagar Gas is:

20% = ₹5.7b ÷ ₹29b (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.20 in profit.

What Has ROE Got To Do With 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 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.

Mahanagar Gas' Earnings Growth And 20% ROE

At first glance, Mahanagar Gas seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 23%. This certainly adds some context to Mahanagar Gas' moderate 16% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Mahanagar Gas' reported growth was lower than the industry growth of 23% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Mahanagar Gas''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Mahanagar Gas Using Its Retained Earnings Effectively?

Mahanagar Gas has a three-year median payout ratio of 27%, which implies that it retains the remaining 73% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Mahanagar Gas has paid dividends over a period of four years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

On the whole, we feel that Mahanagar Gas' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 1 risk we have identified for Mahanagar Gas visit our risks dashboard for free.

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This article by Simply Wall St is general in nature. 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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