Elementia. de's (BMV:ELEMENT) stock is up by a considerable 13% over the past month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Elementia. de's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
ROE 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 Elementia. de is:
3.0% = Mex$630m ÷ Mex$21b (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each MX$1 of shareholders' capital it has, the company made MX$0.03 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. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Elementia. de's Earnings Growth And 3.0% ROE
As you can see, Elementia. de's ROE looks pretty weak. Not just that, even compared to the industry average of 14%, the company's ROE is entirely unremarkable. For this reason, Elementia. de's five year net income decline of 43% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.
However, when we compared Elementia. de's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.8% in the same period. This is quite worrisome.
Earnings growth is an important metric to consider when valuing a stock. 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 Elementia. de is trading on a high P/E or a low P/E, relative to its industry.
Is Elementia. de Making Efficient Use Of Its Profits?
On the whole, we feel that the performance shown by Elementia. de can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard will have the 1 risk we have identified for Elementia. de.
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