Is Weakness In Elspec Engineering Ltd (TLV:ELSPC) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

Elspec Engineering (TLV:ELSPC) has had a rough three months with its share price down 26%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

We've discovered 3 warning signs about Elspec Engineering. View them for free.

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:

15% = ₪13m ÷ ₪84m (Based on the trailing twelve months to December 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ₪1 worth of shareholders' equity, the company generated ₪0.15 in profit.

See our latest analysis for Elspec Engineering

Why Is ROE Important For 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Elspec Engineering's Earnings Growth And 15% ROE

At first glance, Elspec Engineering seems to have a decent ROE. On comparing with the average industry ROE of 8.4% the company's ROE looks pretty remarkable. Probably as a result of this, Elspec Engineering was able to see a decent growth of 18% over the last five years.

As a next step, we compared Elspec Engineering's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 13%.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Efficiently Re-investing Its Profits?

Elspec Engineering has a three-year median payout ratio of 36%, which implies that it retains the remaining 64% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Besides, Elspec Engineering has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

Overall, we are quite pleased with Elspec Engineering's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 3 risks we have identified for Elspec Engineering by visiting our risks dashboard for free on our platform here.

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.