Will Weakness in Mahanagar Gas Limited's (NSE:MGL) Stock Prove Temporary Given Strong Fundamentals?

It is hard to get excited after looking at Mahanagar Gas' (NSE:MGL) recent performance, when its stock has declined 5.9% over the past week. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Mahanagar 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.

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

How Do You 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:

19% = ₹10b ÷ ₹55b (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.19 in profit.

View our latest analysis for Mahanagar Gas

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.

Mahanagar Gas' Earnings Growth And 19% ROE

To start with, Mahanagar Gas' ROE looks acceptable. Further, the company's ROE is similar to the industry average of 16%. Consequently, this likely laid the ground for the decent growth of 14% seen over the past five years by Mahanagar Gas.

We then compared Mahanagar Gas' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 4.4% in the same 5-year 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. Doing so will help them establish if the stock's future looks promising or ominous. What is MGL worth today? The intrinsic value infographic in our free research report helps visualize whether MGL is currently mispriced by the market.

Is Mahanagar Gas Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 30% (implying that the company retains 70% of its profits), it seems that Mahanagar Gas is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Mahanagar Gas has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 34%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 17%.

Summary

On the whole, we feel that Mahanagar Gas' performance has been quite good. 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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.