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

Nextcom (TLV:NXTM) has had a great run on the share market with its stock up by a significant 63% 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 Nextcom's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Nextcom

How To 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 Nextcom is:

16% = ₪12m ÷ ₪74m (Based on the trailing twelve months to June 2020).

The 'return' is the profit 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 ₪0.16 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Nextcom's Earnings Growth And 16% ROE

To begin with, Nextcom seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.9%. This certainly adds some context to Nextcom's exceptional 39% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Nextcom'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 6.3%.

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

Is Nextcom Efficiently Re-investing Its Profits?

Nextcom has a really low three-year median payout ratio of 17%, meaning that it has the remaining 83% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Nextcom is determined to keep sharing its profits with shareholders which we infer from its long history of seven years of paying a dividend.

Conclusion

In total, we are pretty happy with Nextcom'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. 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. Our risks dashboard would have the 3 risks we have identified for Nextcom.

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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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