Has Precot Limited's (NSE:PRECOT) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Simply Wall St · 10/16 00:08

Precot (NSE:PRECOT) has had a great run on the share market with its stock up by a significant 11% over the last week. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Precot's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Precot

How Do You Calculate Return On Equity?

Return on equity 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 Precot is:

7.0% = ₹293m ÷ ₹4.2b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.07 in profit.

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. 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.

Precot's Earnings Growth And 7.0% ROE

It is quite clear that Precot's ROE is rather low. An industry comparison shows that the company's ROE is not much different from the industry average of 7.9% either. However, the modest 10% net income growth seen by Precot over the past five years is a positive sign. We reckon that there could also be other factors at play that are influencing the company's growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Precot's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 19% in the same period.

past-earnings-growth
NSEI:PRECOT Past Earnings Growth October 16th 2024

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Precot fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Precot Efficiently Re-investing Its Profits?

In Precot's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 10% (or a retention ratio of 90%), which suggests that the company is investing most of its profits to grow its business.

Besides, Precot has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

Overall, we feel that Precot certainly does have some positive factors to consider. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 4 risks we have identified for Precot by visiting our risks dashboard for free on our platform here.