It is hard to get excited after looking at Eleco's (LON:ELCO) recent performance, when its stock has declined 4.1% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Eleco's ROE in this article.
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.
Check out our latest analysis for Eleco
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Eleco is:
9.2% = UK£2.3m ÷ UK£25m (Based on the trailing twelve months to June 2022).
The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.09 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Eleco's Earnings Growth And 9.2% ROE
To begin with, Eleco seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 8.6%. This probably goes some way in explaining Eleco's moderate 11% growth over the past five years amongst other factors.
Next, on comparing with the industry net income growth, we found that Eleco's growth is quite high when compared to the industry average growth of 9.4% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Eleco's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Eleco Efficiently Re-investing Its Profits?
Eleco has a low three-year median payout ratio of 14%, meaning that the company retains the remaining 86% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Besides, Eleco has been paying dividends over a period of six years. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 17%. Regardless, the future ROE for Eleco is predicted to rise to 11% despite there being not much change expected in its payout ratio.
On the whole, we feel that Eleco's performance has been quite good. 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 sizeable growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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