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The financials of Kirloskar Oil Engines Limited (NSE:KIRLOSENG) are too murky to relate to current share price dynamics: what does the stock hold?

Kirloskar Oil Engines (NSE: KIRLOSENG) has had a strong run in the equity market, with its stock rising 81% in the past three months. However, we wonder if the company’s inconsistent financial statements would negatively impact the current share price dynamics. In particular, we will pay attention to the ROE of Kirloskar Oil Engines today.

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 is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.

Check opportunities and risks within the IN Machinery industry.

How do you calculate return on equity?

ROE can be calculated using the formula:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the above formula, the ROE for Kirloskar oil engines is:

11% = ₹2.2 billion ÷ ₹21 billion (based on the last twelve months to June 2022).

The “return” is the annual profit. This means that for every ₹1 of equity, the company generated ₹0.11 of profit.

What does ROE have to do with 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. Assuming everything else remains unchanged, the higher the ROE and earnings retention, the higher a company’s growth rate relative to companies that don’t necessarily exhibit these characteristics.

Kirloskar Oil Engines profit growth and 11% ROE

When you first look at it, the ROE of Kirloskar Oil Engines doesn’t look so appealing. Yet further investigation shows that the company’s ROE is similar to the industry average of 13%. That said, Kirloskar Oil Engines has posted low net income growth of 2.5% over the past five years. Remember that the company’s ROE is not particularly good to start with. So this could also be one of the reasons for the company’s weak earnings growth.

We then compared Kirloskar Oil Engines’ net profit growth with the industry and found that the company’s growth figure is below the industry average growth rate of 15% over the same period, which is a little worrying.

NSEI:KIRLOSENG Past Earnings Growth October 11, 2022

Earnings growth is an important factor in stock valuation. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. This will help them determine if the future of the title looks bright or ominous. A good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings outlook. Thus, you may want to check whether Kirloskar Oil Engines is trading on a high P/E or a low P/E, relative to its industry.

Does Kirloskar Oil Engines use its profits efficiently?

Despite a moderate three-year median payout ratio of 30% (implying the company retains the remaining 70% of its revenue), Kirloskar Oil Engines’ earnings growth has been quite weak. So there could be another explanation for this. For example, the company’s business may deteriorate.

Moreover, Kirloskar Oil Engines has been paying dividends for at least ten years, suggesting that management must have perceived that shareholders preferred dividends to earnings growth.

Conclusion

All in all, we are a bit ambivalent about the performance of Kirloskar Oil Engines. Although the company has a high reinvestment rate, the low ROE means that all this reinvestment does not benefit its investors and, moreover, it has a negative impact on earnings growth. That said, the latest analyst forecasts show that the company will continue to see earnings expansion. Are these analyst expectations based on general industry expectations or company fundamentals? Click here to access our analyst forecast page for the company.

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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