Most readers would already be aware that Birla’s (NSE:BIRLACORPN) stock increased significantly by 60% over the past three months. We wonder if and what role the company’s financials play in that price change as a company’s long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Birla’s ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
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 Birla is:
11% = ₹6.3b ÷ ₹55b (Based on the trailing twelve months to March 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 ₹0.11.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
A Side By Side comparison of Birla’s Earnings Growth And 11% ROE
When you first look at it, Birla’s ROE doesn’t look that attractive. However, given that the company’s ROE is similar to the average industry ROE of 14%, we may spare it some thought. Particularly, the exceptional 32% net income growth seen by Birla over the past five years is pretty remarkable. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company’s management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared Birla’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 17%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you’re wondering about Birla’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Birla Using Its Retained Earnings Effectively?
Birla’s ‘ three-year median payout ratio is on the lower side at 23% implying that it is retaining a higher percentage (77%) of its profits. So it looks like Birla is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Moreover, Birla is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 8.0% over the next three years. However, the company’s ROE is not expected to change by much despite the lower expected payout ratio.
On the whole, we do feel that Birla has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company’s earnings growth is expected to slow down. 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. 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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