Eternit S.A.'s (BVMF:ETER3) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Most readers would already be aware that Eternit's (BVMF:ETER3) stock increased significantly by 23% over the past week. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Eternit's ROE.

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.

View our latest analysis for Eternit

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 Eternit is:

54% = R$44m ÷ R$81m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every R$1 worth of shareholders' equity, the company generated R$0.54 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Eternit's Earnings Growth And 54% ROE

To begin with, Eternit has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 5.2% also doesn't go unnoticed by us. Needless to say, we are quite surprised to see that Eternit's net income shrunk at a rate of 12% over the past five years. So, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

That being said, we compared Eternit's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 7.2% in the same period.

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 Eternit is trading on a high P/E or a low P/E, relative to its industry.

Is Eternit Using Its Retained Earnings Effectively?

Eternit doesn't pay any dividend, meaning that potentially all of its profits are being reinvested in the business, which doesn't explain why the company's earnings have shrunk if it is retaining all of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Conclusion

In total, it does look like Eternit has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its 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. You can see the 4 risks we have identified for Eternit by visiting our risks dashboard for free on our platform here.

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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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