Telrad Networks Ltd (TLV:TLRD) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

By
Simply Wall St
Published
August 19, 2021
TASE:TLRD
Source: Shutterstock

Telrad Networks (TLV:TLRD) has had a rough three months with its share price down 24%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Telrad Networks' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Telrad Networks

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Telrad Networks is:

35% = US$9.7m ÷ US$28m (Based on the trailing twelve months to March 2021).

The 'return' is the yearly profit. One way to conceptualize this is that for each ₪1 of shareholders' capital it has, the company made ₪0.35 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Telrad Networks' Earnings Growth And 35% ROE

Firstly, we acknowledge that Telrad Networks has a significantly high ROE. Secondly, even when compared to the industry average of 6.9% the company's ROE is quite impressive. As you might expect, the 40% net income decline reported by Telrad Networks doesn't bode well with us. 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.

So, as a next step, we compared Telrad Networks' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 4.3% in the same period.

past-earnings-growth
TASE:TLRD Past Earnings Growth August 20th 2021

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). 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 Telrad Networks is trading on a high P/E or a low P/E, relative to its industry.

Is Telrad Networks Using Its Retained Earnings Effectively?

While the company did payout a portion of its dividend in the past, it currently doesn't pay a dividend. This implies that potentially all of its profits are being reinvested in the business.

Summary

Overall, we feel that Telrad Networks certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 4 risks we have identified for Telrad Networks.

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