Eleco Plc's (LON:ELCO) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?
Eleco (LON:ELCO) has had a great run on the share market with its stock up by a significant 14% over the last three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Eleco's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Eleco
How Is ROE Calculated?
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 Eleco is:
8.1% = UK£2.1m ÷ UK£26m (Based on the trailing twelve months to June 2023).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.08 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 8.1% ROE
At first glance, Eleco's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 10%. We can see that Eleco has grown at a five year net income growth average rate of 2.9%, which is a bit on the lower side. Bear in mind, the company's ROE is not very high . Hence, this does provide some context to low earnings growth seen by the company.
Next, on comparing with the industry net income growth, we found that Eleco's reported growth was lower than the industry growth of 9.1% over the last few years, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is ELCO fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Eleco Efficiently Re-investing Its Profits?
Eleco's low three-year median payout ratio of 20% (or a retention ratio of 80%) should mean that the company is retaining most of its earnings to fuel its growth. This should be reflected in its earnings growth number, but that's not the case. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Moreover, Eleco has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 16% of its profits over the next three years. However, Eleco's ROE is predicted to rise to 16% despite there being no anticipated change in its payout ratio.
Summary
Overall, we have mixed feelings about Eleco. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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. 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.
