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Most readers would already be aware that Exco Technologies' (TSE:XTC) stock increased significantly by 36% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Exco Technologies' ROE.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Exco Technologies is:
9.0% = CA$30m ÷ CA$335m (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.09 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Exco Technologies' Earnings Growth And 9.0% ROE
On the face of it, Exco Technologies' ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.0%. Having said that, Exco Technologies' five year net income decline rate was 12%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.
As a next step, we compared Exco Technologies' performance with the industry and found thatExco Technologies' performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 7.9% in the same period, which is a slower than the company.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Exco Technologies''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Exco Technologies Using Its Retained Earnings Effectively?
In spite of a normal three-year median payout ratio of 46% (that is, a retention ratio of 54%), the fact that Exco Technologies' earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
In addition, Exco 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.
On the whole, we feel that the performance shown by Exco Technologies can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.
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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