Will Weakness in Raval ACS Ltd.'s (TLV:RVL) Stock Prove Temporary Given Strong Fundamentals?

Raval ACS (TLV:RVL) has had a rough month with its share price down 3.8%. 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 Raval ACS' 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Raval ACS

How Do You 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 Raval ACS is:

15% = €15m ÷ €100m (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ₪1 of shareholders' capital it has, the company made ₪0.15 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Raval ACS' Earnings Growth And 15% ROE

At first glance, Raval ACS seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 5.8%. Probably as a result of this, Raval ACS was able to see a decent growth of 10.0% over the last five years.

When you consider the fact that the industry earnings have shrunk at a rate of 2.5% in the same period, the company's net income growth is pretty remarkable.

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

Is Raval ACS Efficiently Re-investing Its Profits?

Raval ACS doesn't pay any dividend, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.

Conclusion

On the whole, we feel that Raval ACS' performance has been quite good. 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 1 risk we have identified for Raval ACS 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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