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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.