Elco (TLV: ELCO) has performed well in the equity market with a significant 10% increase in its share over the past three months. As most know, fundamentals typically guide long-term market price movements, so we decided to look at the company’s key financial metrics today to see if they have a role to play in the recent one. price movement. In particular, we will be paying close attention to Elco’s ROE today.
Return on equity or ROE is a key metric used to assess the efficiency with which the management of a company uses company capital. Simply put, it is used to assess a company’s profitability against its equity.
See our latest review for Elco
How is the ROE calculated?
the formula for ROE is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Elco is:
14% = US $ 138 million ÷ US $ 971 million (based on the last twelve months to March 2021).
The “return” is the amount earned after tax over the past twelve months. One way to conceptualize this is that for every 1 of shareholders’ capital it has, the company made 0.14 of profit.
What does ROE have to do with profit growth?
So far we’ve learned that ROE measures how efficiently a business generates profits. We now need to assess how much profit the company is reinvesting or “holding back” for future growth, which then gives us an idea of the growth potential of the company. Assuming everything else remains the same, the higher the ROE and profit retention, the higher the growth rate of a business compared to businesses that don’t necessarily have these characteristics.
Elco profit growth and 14% ROE
For starters, Elco appears to have a respectable ROE. Even compared to the industry average of 14%, the company’s ROE looks pretty decent. For this reason, Elco’s 15% drop in net income over five years raises the question of why decent ROE has not translated into growth. We believe there might be other factors at play here that are preventing the growth of the business. For example, the company may have a high payout ratio or the company may have misallocated capital, for example.
That being said, we compared Elco’s performance to that of the industry and got concerned when we found out that while the company cut profits, the industry increased profits at a rate of 6. , 8% over the same period.
The basis for attaching value to a business is, to a large extent, related to the growth of its profits. The investor should try to establish whether the expected growth or decline in earnings, as the case may be, is taken into account. In doing so, he’ll have an idea if the action is heading for clear blue waters or swampy waters ahead. A good indicator of expected earnings growth is the P / E ratio which determines the price the market is willing to pay for a stock based on its earnings outlook. So, you might want to check if Elco is trading high P / E or low P / E, relative to its industry.
Is Elco Efficiently Reinvesting Its Profits?
Despite a normal median payout rate of 30% over three years (i.e. a retention rate of 70%), the fact that Elco’s profits have declined is quite disconcerting. There could therefore be other explanations in this regard. For example, the business of the company can deteriorate.
Additionally, Elco has been paying dividends for at least ten years or more, suggesting that management must have perceived that shareholders prefer dividends over earnings growth.
All in all, it seems that Elco has some positive aspects for its business. However, we are disappointed to see a lack of earnings growth despite a high ROE and reinvestment rate. We believe there could be external factors that could negatively impact the business. While we don’t completely reject the business, what we would do is try to determine how risky the business is to make a more informed decision about the business. You can see the 2 risks we have identified for Elco by visiting our risk dashboard for free on our platform here.
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