Elco Ltd.'s (TLV:ELCO) Stock Is Going Strong: Is the Market Following Fundamentals?

Elco's (TLV:ELCO) stock is up by a considerable 16% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Elco's ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Elco

How To 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 Elco is:

17% = ₪537m ÷ ₪3.1b (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 ₪0.17 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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 Elco's Earnings Growth And 17% ROE

To start with, Elco's ROE looks acceptable. Especially when compared to the industry average of 14% the company's ROE looks pretty impressive. Probably as a result of this, Elco was able to see a decent growth of 6.3% over the last five years.

As a next step, we compared Elco's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 10% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 Elco is trading on a high P/E or a low P/E, relative to its industry.

Is Elco Making Efficient Use Of Its Profits?

Elco has a healthy combination of a moderate three-year median payout ratio of 28% (or a retention ratio of 72%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Moreover, Elco is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

Overall, we are quite pleased with Elco's 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 a good amount of 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 2 risks we have identified for Elco 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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