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Eleco Plc's (LON:ELCO) Stock Been Rising: Are Strong Financials Guiding The Market?

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Eleco's (LON:ELCO) stock up by 4.8% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Eleco's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Eleco

How Is ROE Calculated?

Return on equity 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:

11% = UK£2.7m ÷ UK£24m (Based on the trailing twelve months to December 2021).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.11 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. 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.

Eleco's Earnings Growth And 11% ROE

To begin with, Eleco seems to have a respectable ROE. On comparing with the average industry ROE of 9.0% the company's ROE looks pretty remarkable. This certainly adds some context to Eleco's decent 17% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Eleco's growth is quite high when compared to the industry average growth of 13% in the same period, which is great to see.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One 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 prospects. So, you may want to check if Eleco is trading on a high P/E or a low P/E, relative to its industry.

Is Eleco Using Its Retained Earnings Effectively?

In Eleco's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 14% (or a retention ratio of 86%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Eleco is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 17% of its profits over the next three years. Accordingly, forecasts suggest that Eleco's future ROE will be 12% which is again, similar to the current ROE.

Conclusion

On the whole, we feel that Eleco's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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