Asian Paints (NSE:ASIANPAINT) has had a great run on the share market with its stock up by a significant 24% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Asian Paints’ ROE.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
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 Asian Paints is:
20% = ₹23b ÷ ₹114b (Based on the trailing twelve months to September 2020).
The ‘return’ is the income the business earned over the last year. So, this means that for every ₹1 of its shareholder’s investments, the company generates a profit of ₹0.20.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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 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.
Asian Paints’ Earnings Growth And 20% ROE
To start with, Asian Paints’ ROE looks acceptable. Especially when compared to the industry average of 11% the company’s ROE looks pretty impressive. This certainly adds some context to Asian Paints’ decent 8.9% net income growth seen over the past five years.
Next, on comparing with the industry net income growth, we found that Asian Paints’ reported growth was lower than the industry growth of 16% in the same period, which is not something we like to see.
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). Doing so will help them establish if the stock’s future looks promising or ominous. If you’re wondering about Asian Paints”s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Asian Paints Efficiently Re-investing Its Profits?
Asian Paints has a healthy combination of a moderate three-year median payout ratio of 42% (or a retention ratio of 58%) 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, Asian Paints has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts’ consensus data, we found that the company is expected to keep paying out approximately 41% of its profits over the next three years. However, Asian Paints’ ROE is predicted to rise to 28% despite there being no anticipated change in its payout ratio.
In total, we are pretty happy with Asian Paints’ performance. 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 respectable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company’s earnings are expected to accelerate. 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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