Engenco Limited's (ASX:EGN) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

Engenco (ASX:EGN) has had a rough three months with its share price down 12%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Engenco's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Engenco

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 Engenco is:

17% = AU$15m ÷ AU$89m (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.17 in profit.

Why Is ROE Important For 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.

Engenco's Earnings Growth And 17% ROE

At first glance, Engenco seems to have a decent ROE. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. This probably laid the ground for Engenco's significant 22% net income growth seen over the past five years. We reckon that there could also be other factors at play here. 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 Engenco's reported growth was lower than the industry growth of 34% in the same period, 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. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Engenco fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Engenco Using Its Retained Earnings Effectively?

Engenco has a three-year median payout ratio of 37% (where it is retaining 63% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Engenco is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Engenco has paid dividends over a period of four years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

On the whole, we feel that Engenco's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard will have the 1 risk we have identified for Engenco.

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This article by Simply Wall St is general in nature. 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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