Torrent Power (NSE:TORNTPOWER) has had a great run in the stock market with its shares rising significantly by 19% in the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on current share price momentum. Specifically, we decided to study Torrent Power's ROE in this article.
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 index that measures the rate of return on the capital contributed by the company's shareholders.
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How is return on capital calculated?
He formula for return on capital is:
Return on equity = Net profit (from continuing operations) รท Shareholders' equity
So, based on the above formula, Torrent Power's ROE is:
11% = โน12b รท โน113b (based on the last twelve months up to December 2022).
'Performance' refers to a company's earnings over the past year. So this means that for every โน1 of its shareholders' investments, the company generates a profit of โน0.11.
What is the relationship between ROE and earnings growth?
So far, we have learned that ROE is a measure of a company's profitability. Now we need to assess how much profit is reinvested or "retained" by the company for future growth, which gives us an idea of โโthe company's growth potential. Assuming all else being equal, companies that have a higher return on equity and higher earnings retention are typically the ones with a higher growth rate compared to companies that do not have the same characteristics.
A side-by-side comparison of Torrent Power earnings growth and 11% ROE
At first glance, Torrent Power's ROE does not look very promising. However, since the company's ROE is similar to the industry average ROE of 9.6%, we can give it some thought. That being said, Torrent Power's net income growth over the last five years is more or less flat. Remember, the company's ROE is not particularly good to begin with. So this provides some context for the flat earnings growth seen by the company.
As a next step, we compare Torrent Power's net income growth with the industry and find that the company's growth is slightly below the industry average growth of 0.6% over the same period.
Earnings growth is a very important factor in stock valuation. The investor should try to establish whether the expected growth or decline in earnings, whichever the case, is included in the price. This helps them determine whether stocks are set for a bright or bleak future. Is TORNTPOWER fairly valued? This company intrinsic value infographic it has everything you need to know.
Is Torrent Power making efficient use of its benefits?
Despite having a modest three-year average payout ratio of 39% (meaning the company retains 61% of earnings) over the past three-year period, Torrent Power's earnings growth was more than or less flat. So there could be some other explanation along those lines. For example, the company's business may be deteriorating.
Additionally, Torrent Power has been paying dividends for a period of at least ten years, suggesting that maintaining dividend payments is much more important to management, even if it comes at the cost of business growth. Looking at the latest analyst consensus data, we find that the company is expected to keep paying out roughly 36% of its earnings over the next three years. Regardless, Torrent Power's future ROE is anticipated to rise to 17% despite not much change in its payout ratio being expected.
Conclusion
Overall, we feel that the performance displayed by Torrent Power may be open to many interpretations. While the company has a high earnings retention rate, its low rate of return is likely hampering its earnings growth. Having said that, looking at current analyst estimates, we find that the company's earnings growth rate is expected to see a big improvement. Are these analysts' expectations based on general industry expectations or on company fundamentals? Click here to go to our analyst forecast page for the company.
Valuation is complex, but we are helping to simplify it.
Find out if torrent power is potentially overvalued or undervalued by consulting our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, internal transactions and financial health.
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This Simply Wall St article is general in nature. We provide feedback based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell any stock, and it does not take into account your goals or financial situation. Our goal is to provide you with long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative material. Simply Wall St does not have a position in any of the mentioned stocks.
