Is Weakness In EC2 S.A. (WSE:EC2) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 8.7% over the past three months, it is easy to disregard EC2 (WSE:EC2). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on EC2'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for EC2

How Do You Calculate Return On Equity?

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 EC2 is:

40% = zł831k ÷ zł2.1m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. So, this means that for every PLN1 of its shareholder's investments, the company generates a profit of PLN0.40.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of EC2's Earnings Growth And 40% ROE

Firstly, we acknowledge that EC2 has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 23% also doesn't go unnoticed by us. This likely paved the way for the modest 8.6% net income growth seen by EC2 over the past five years. growth

Next, on comparing with the industry net income growth, we found that EC2's reported growth was lower than the industry growth of 15% in the same period, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is EC2 fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is EC2 Efficiently Re-investing Its Profits?

EC2 doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the decent earnings growth number that we discussed above.

Conclusion

On the whole, we feel that EC2's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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. To know the 2 risks we have identified for EC2 visit our risks dashboard for free.

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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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