Is Weakness In Enghouse Systems Limited (TSE:ENGH) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

By
Simply Wall St
Published
December 29, 2020
TSX:ENGH
Source: Shutterstock

With its stock down 17% over the past three months, it is easy to disregard Enghouse Systems (TSE:ENGH). 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 Enghouse Systems' ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Enghouse Systems

How Do You Calculate Return On Equity?

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 Enghouse Systems is:

20% = CA$99m ÷ CA$496m (Based on the trailing twelve months to October 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.20 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Enghouse Systems' Earnings Growth And 20% ROE

To start with, Enghouse Systems' ROE looks acceptable. Even when compared to the industry average of 20% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 19% seen over the past five years by Enghouse Systems.

As a next step, we compared Enghouse Systems' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 16%.

past-earnings-growth
TSX:ENGH Past Earnings Growth December 30th 2020

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for ENGH? You can find out in our latest intrinsic value infographic research report.

Is Enghouse Systems Efficiently Re-investing Its Profits?

Enghouse Systems has a three-year median payout ratio of 34%, which implies that it retains the remaining 66% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Enghouse Systems has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 39%.

Conclusion

In total, we are pretty happy with Enghouse Systems' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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