Elmos Semiconductor (ETR:ELG) has had a great run on the share market with its stock up by a significant 26% over the last month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Elmos Semiconductor's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Elmos Semiconductor is:
0.6% = €1.7m ÷ €305m (Based on the trailing twelve months to September 2020).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.01 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Elmos Semiconductor's Earnings Growth And 0.6% ROE
It is quite clear that Elmos Semiconductor's ROE is rather low. Not just that, even compared to the industry average of 3.6%, the company's ROE is entirely unremarkable. Therefore, the disappointing ROE therefore provides a background to Elmos Semiconductor's very little net income growth of 4.1% over the past five years.
We then compared Elmos Semiconductor's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 35% in the same period, which is a bit concerning.
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. 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 Elmos Semiconductor's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Elmos Semiconductor Making Efficient Use Of Its Profits?
Despite having a normal three-year median payout ratio of 34% (or a retention ratio of 66% over the past three years, Elmos Semiconductor has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Moreover, Elmos Semiconductor has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 38%. Still, forecasts suggest that Elmos Semiconductor's future ROE will rise to 7.4% even though the the company's payout ratio is not expected to change by much.
Overall, we have mixed feelings about Elmos Semiconductor. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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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