Eurocell plc's (LON:ECEL) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?
With its stock down 4.6% over the past three months, it is easy to disregard Eurocell (LON:ECEL). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Eurocell'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Eurocell
How Do You Calculate Return On Equity?
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 Eurocell is:
27% = UK£19m ÷ UK£71m (Based on the trailing twelve months to December 2019).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.27 in profit.
What Has ROE Got To Do With 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.
Eurocell's Earnings Growth And 27% ROE
Firstly, we acknowledge that Eurocell has a significantly high ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. Probably as a result of this, Eurocell was able to see a decent net income growth of 8.7% over the last five years.
We then compared Eurocell's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 6.9% in the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is ECEL fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Eurocell Using Its Retained Earnings Effectively?
Eurocell has a three-year median payout ratio of 47%, which implies that it retains the remaining 53% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.
Moreover, Eurocell is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 49%. Still, forecasts suggest that Eurocell's future ROE will drop to 17% even though the the company's payout ratio is not expected to change by much.
Summary
In total, we are pretty happy with Eurocell's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 3 risks we have identified for Eurocell visit our risks dashboard for free.
This article by Simply Wall St is general in nature. 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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