Elspec Engineering Ltd.'s (TLV:ELSPC) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Elspec Engineering's (TLV:ELSPC) stock is up by a considerable 69% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Elspec Engineering's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Elspec Engineering

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 Elspec Engineering is:

13% = ₪7.8m ÷ ₪60m (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every ₪1 worth of equity, the company was able to earn ₪0.13 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Elspec Engineering's Earnings Growth And 13% ROE

To start with, Elspec Engineering's ROE looks acceptable. Especially when compared to the industry average of 7.7% the company's ROE looks pretty impressive. Despite this, Elspec Engineering's five year net income growth was quite flat over the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

We then compared Elspec Engineering's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 24% in the same period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Elspec Engineering's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Elspec Engineering Using Its Retained Earnings Effectively?

Elspec Engineering doesn't pay any dividend, which means that it is retaining all of its earnings. This makes us question why the company is retaining so much of its profits and still generating almost no growth? So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Summary

In total, it does look like Elspec Engineering has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Elspec Engineering's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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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