ESCO Technologies Inc.'s (NYSE:ESE) Has Performed Well But Fundamentals Look Varied: Is There A Clear Direction For The Stock?
ESCO Technologies' (NYSE:ESE) stock is up by 9.1% over the past three months. However, we decided to study the company's mixed-bag of fundamentals to assess what this could mean for future share prices, as stock prices tend to be aligned with a company's long-term financial performance. Specifically, we decided to study ESCO Technologies' ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Check out our latest analysis for ESCO Technologies
How To 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 ESCO Technologies is:
7.0% = US$72m ÷ US$1.0b (Based on the trailing twelve months to June 2022).
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 Is The Relationship Between ROE And 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. 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.
ESCO Technologies' Earnings Growth And 7.0% ROE
At first glance, ESCO Technologies' ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 13%. For this reason, ESCO Technologies' five year net income decline of 8.7% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
So, as a next step, we compared ESCO Technologies' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 8.6% in the same period.
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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about ESCO Technologies''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is ESCO Technologies Efficiently Re-investing Its Profits?
ESCO Technologies' low three-year median payout ratio of 13% (implying that it retains the remaining 87% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.
In addition, ESCO Technologies has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
Conclusion
In total, we're a bit ambivalent about ESCO Technologies' performance. 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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