Could The Market Be Wrong About Torrent Power Limited (NSE:TORNTPOWER) Given Its Attractive Financial Prospects?

With its stock down 12% over the past month, it is easy to disregard Torrent Power (NSE:TORNTPOWER). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Torrent Power's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

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How Do You 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 Torrent Power is:

17% = ₹24b ÷ ₹139b (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.17 in profit.

Check out our latest analysis for Torrent Power

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Torrent Power's Earnings Growth And 17% ROE

To begin with, Torrent Power seems to have a respectable ROE. On comparing with the average industry ROE of 7.0% the company's ROE looks pretty remarkable. This probably laid the ground for Torrent Power's moderate 19% net income growth seen over the past five years.

As a next step, we compared Torrent Power's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 2.0%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Torrent Power's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Torrent Power Using Its Retained Earnings Effectively?

Torrent Power has a healthy combination of a moderate three-year median payout ratio of 37% (or a retention ratio of 63%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Torrent Power has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 45% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Conclusion

Overall, we are quite pleased with Torrent Power's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.