ECS Botanics Holdings Ltd's (ASX:ECS) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

ECS Botanics Holdings (ASX:ECS) has had a great run on the share market with its stock up by a significant 23% over the last week. 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 ECS Botanics Holdings' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for ECS Botanics Holdings

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for ECS Botanics Holdings is:

2.2% = AU$491k ÷ AU$22m (Based on the trailing twelve months to June 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.02 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of ECS Botanics Holdings' Earnings Growth And 2.2% ROE

It is quite clear that ECS Botanics Holdings' ROE is rather low. Even when compared to the industry average of 20%, the ROE figure is pretty disappointing. However, we we're pleasantly surprised to see that ECS Botanics Holdings grew its net income at a significant rate of 31% in the last five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

As a next step, we compared ECS Botanics Holdings' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 31% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about ECS Botanics Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is ECS Botanics Holdings Using Its Retained Earnings Effectively?

ECS Botanics Holdings doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Summary

Overall, we feel that ECS Botanics Holdings certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard will have the 1 risk we have identified for ECS Botanics Holdings.

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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.