Are Eckoh plc's (LON:ECK) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

It is hard to get excited after looking at Eckoh's (LON:ECK) recent performance, when its stock has declined 16% over the past month. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Eckoh's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Eckoh

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Eckoh is:

10% = UK£4.5m ÷ UK£45m (Based on the trailing twelve months to March 2024).

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 £0.10 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. 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.

Eckoh's Earnings Growth And 10% ROE

At first glance, Eckoh seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 15% does temper our expectations. Eckoh was still able to see a decent net income growth of 11% over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the fairly high earnings growth seen by the company.

As a next step, we compared Eckoh's 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 12% 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. Doing so will help them establish if the stock's future looks promising or ominous. What is ECK worth today? The intrinsic value infographic in our free research report helps visualize whether ECK is currently mispriced by the market.

Is Eckoh Using Its Retained Earnings Effectively?

Eckoh has a significant three-year median payout ratio of 58%, meaning that it is left with only 42% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Besides, Eckoh has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 36% over the next three years. The fact that the company's ROE is expected to rise to 16% over the same period is explained by the drop in the payout ratio.

Conclusion

In total, it does look like Eckoh has some positive aspects to its business. Namely, its significant earnings growth, to which its moderate rate of return likely contributed. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.