Nelcast (NSE:NELCAST) stock is up 50% in the past three months. But the company’s key financial indicators seem to differ across the board, leading us to wonder whether the company’s current share price momentum can be sustained or not. In this article, we decided to focus on the ROE of Nelcast.
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In other words, it reveals the company’s success in turning shareholders’ investments into profits.
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How to calculate return on equity?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Nelcast is:
4.5% = ₹200 million ÷ ₹4.4 billion (based on past twelve months to June 2022).
“Yield” is the income the business has earned over the past year. So this means that for every ₹1 of its shareholder’s investment, the company generates a profit of ₹0.04.
Why is ROE important for earnings growth?
So far we have learned that ROE is a measure of a company’s profitability. Depending on how much of those earnings the company reinvests or “keeps”, and how efficiently it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.
A side-by-side comparison of Nelcast’s earnings growth and ROE of 4.5%
As you can see, Nelcast’s ROE seems quite low. Even compared to the industry average ROE of 15%, the company’s ROE is pretty dismal. Given the circumstances, the significant decline in net income of 25% experienced by Nelcast over the past five years is not surprising. We believe there could be other factors at play here as well. For example, the company has misallocated capital or the company has a very high payout ratio.
That being said, we benchmarked Nelcast’s performance against the industry and were concerned when we found that while the company had cut profits, the industry had increased profits at a rate of 24% over the same period.
The basis for attaching value to a company is, to a large extent, linked to the growth of its profits. The investor should try to establish whether the expected growth or decline in earnings, as the case may be, is taken into account. This then helps them determine whether the action is placed for a bright or bleak future. Is Nelcast correctly valued compared to other companies? These 3 assessment metrics might help you decide.
Is Nelcast effectively using its retained earnings?
Nelcast’s low three-year median payout ratio of 19% (implying it keeps the remaining 81% of its earnings) comes as a surprise when you pair it with declining earnings. This should generally not be the case when a company retains most of its profits. It seems that there could be other reasons for the lack in this regard. For example, the business might be in decline.
Furthermore, Nelcast has paid dividends over a period of at least ten years, suggesting that maintaining dividend payments is far more important to management, even if it comes at the expense of business growth. .
Overall, we believe that the performance shown by Nelcast can be open to many interpretations. Although the company has a high earnings retention rate, its low rate of return is likely hampering its earnings growth. In conclusion, we would proceed with caution with this business and one way to do that would be to review the risk profile of the business. Our risk dashboard would have the 3 risks we identified for Nelcast.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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