Are Strong Financial Prospects The Force That Is Driving The Momentum In Automatic Bank Services Limited's TLV:SHVA) Stock?

Automatic Bank Services (TLV:SHVA) has had a great run on the share market with its stock up by a significant 40% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Automatic Bank Services' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Automatic Bank Services

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 Automatic Bank Services is:

13% = ₪24m ÷ ₪177m (Based on the trailing twelve months to September 2020).

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 ₪0.13 in profit.

What Has ROE Got To Do With 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 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.

Automatic Bank Services' Earnings Growth And 13% ROE

To begin with, Automatic Bank Services seems to have a respectable ROE. Even so, when compared with the average industry ROE of 17%, we aren't very excited. Automatic Bank Services was still able to see a decent net income growth of 13% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. 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 provides some context to the earnings growth seen by the company.

We then compared Automatic Bank Services' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 6.5% 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. 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 Automatic Bank Services is trading on a high P/E or a low P/E, relative to its industry.

Is Automatic Bank Services Using Its Retained Earnings Effectively?

Summary

On the whole, we feel that Automatic Bank Services' performance has been quite good. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. To know the 1 risk we have identified for Automatic Bank Services visit our risks dashboard for free.

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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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