Stock Analysis

# Elecon Engineering Company Limited's (NSE:ELECON) Stock Is Going Strong: Is the Market Following Fundamentals?

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Elecon Engineering's (NSE:ELECON) stock is up by a considerable 14% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Elecon Engineering's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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## 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 Elecon Engineering is:

16% = ₹1.8b ÷ ₹11b (Based on the trailing twelve months to September 2022).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.16 in profit.

## 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. 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.

## Elecon Engineering's Earnings Growth And 16% ROE

At first glance, Elecon Engineering seems to have a decent ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. Probably as a result of this, Elecon Engineering was able to see an impressive net income growth of 34% over the last 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 Elecon 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%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Elecon Engineering is trading on a high P/E or a low P/E, relative to its industry.

## Is Elecon Engineering Using Its Retained Earnings Effectively?

Elecon Engineering's ' three-year median payout ratio is on the lower side at 7.9% implying that it is retaining a higher percentage (92%) of its profits. 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, Elecon Engineering is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

## Summary

Overall, we are quite pleased with Elecon Engineering's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings.

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