engcon AB (publ)'s (STO:ENGCON B) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at engcon's (STO:ENGCON B) recent performance, when its stock has declined 4.7% over the past week. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on engcon'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for engcon

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for engcon is:

27% = kr184m ÷ kr672m (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every SEK1 of its shareholder's investments, the company generates a profit of SEK0.27.

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. 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 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.

engcon's Earnings Growth And 27% ROE

To begin with, engcon has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 15% which is quite remarkable. However, for some reason, the higher returns aren't reflected in engcon's meagre five year net income growth average of 4.8%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that engcon's reported growth was lower than the industry growth of 14% over the last few years, 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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about engcon's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is engcon Making Efficient Use Of Its Profits?

engcon has a three-year median payout ratio of 81% (implying that it keeps only 19% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

Additionally, engcon started paying a dividend only recently. So it looks like the management must have perceived that shareholders favor dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 44% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 44%, over the same period.

Summary

In total, it does look like engcon has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.