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

Elekta (STO:EKTA B) has had a rough three months with its share price down 23%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Elekta's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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How To Calculate Return On Equity?

The formula for ROE is:

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

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

9.6% = kr1.0b ÷ kr11b (Based on the trailing twelve months to January 2025).

The 'return' is the income the business earned over the last year. So, this means that for every SEK1 of its shareholder's investments, the company generates a profit of SEK0.10.

View our latest analysis for Elekta

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Elekta's Earnings Growth And 9.6% ROE

To start with, Elekta's ROE looks acceptable. Even when compared to the industry average of 9.3% the company's ROE looks quite decent. Despite this, Elekta's five year net income growth was quite flat over the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

As a next step, we compared Elekta's net income growth with the industry and discovered that the industry saw an average growth of 14% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Elekta's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Elekta Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 82% (meaning, the company retains only 18% of profits) for Elekta suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

In addition, Elekta has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 54% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 16%, over the same period.

Conclusion

On the whole, we do feel that Elekta has some positive attributes. 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 industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.