Can Mixed Fundamentals Have A Negative Impact on The Eastern Company (NASDAQ:EML) Current Share Price Momentum?

Eastern (NASDAQ:EML) has had a great run on the share market with its stock up by a significant 19% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Eastern's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Eastern

How Do You 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 Eastern is:

6.5% = US$8.6m ÷ US$132m (Based on the trailing twelve months to December 2023).

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 $0.06 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. 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.

A Side By Side comparison of Eastern's Earnings Growth And 6.5% ROE

When you first look at it, Eastern's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 14%, the company's ROE leaves us feeling even less enthusiastic. For this reason, Eastern's five year net income decline of 8.2% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Eastern's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.4% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Eastern's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Eastern Making Efficient Use Of Its Profits?

Eastern's low three-year median payout ratio of 21% (or a retention ratio of 79%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Eastern 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.

Conclusion

In total, we're a bit ambivalent about Eastern's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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. To know the 1 risk we have identified for Eastern visit our risks dashboard for free.

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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.