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Most readers would already be aware that Emeco Holdings' (ASX:EHL) stock increased significantly by 16% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Emeco Holdings' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To Calculate Return On Equity?
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 Emeco Holdings is:
3.9% = AU$21m ÷ AU$531m (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.04 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Emeco Holdings' Earnings Growth And 3.9% ROE
It is hard to argue that Emeco Holdings' ROE is much good in and of itself. Even when compared to the industry average of 8.2%, the ROE figure is pretty disappointing. However, we we're pleasantly surprised to see that Emeco Holdings grew its net income at a significant rate of 68% in the last five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Emeco Holdings' growth is quite high when compared to the industry average growth of 28% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Emeco Holdings is trading on a high P/E or a low P/E, relative to its industry.
Is Emeco Holdings Efficiently Re-investing Its Profits?
The three-year median payout ratio for Emeco Holdings is 31%, which is moderately low. The company is retaining the remaining 69%. So it seems that Emeco Holdings is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.
Moreover, Emeco Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 35% of its profits over the next three years. However, Emeco Holdings' ROE is predicted to rise to 14% despite there being no anticipated change in its payout ratio.
Overall, we feel that Emeco Holdings certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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. 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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