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.
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.
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.
Valuation is complex, but we're helping make it simple.
Find out whether Elecon Engineering is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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.