In This Article:
Most readers would already be aware that Eleco's (LON:ELCO) stock increased significantly by 21% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Eleco
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Eleco is:
9.7% = UK£2.7m ÷ UK£27m (Based on the trailing twelve months to December 2023).
The 'return' refers to a company's earnings over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.10 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Eleco's Earnings Growth And 9.7% ROE
On the face of it, Eleco's ROE is not much to talk about. However, its ROE is similar to the industry average of 9.7%, so we won't completely dismiss the company. Still, Eleco has seen a flat net income growth over the past five years. Bear in mind, the company's ROE is not very high. Hence, this provides some context to the flat 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 27% over the last few years, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for ELCO? You can find out in our latest intrinsic value infographic research report.