Can Espey Mfg. & Electronics Corp.'s (NYSEMKT:ESP) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Espey Mfg. & Electronics (NYSEMKT:ESP) has had a great run on the share market with its stock up by a significant 30% over the last three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Particularly, we will be paying attention to Espey Mfg. & Electronics' ROE today.

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.

View our latest analysis for Espey Mfg. & Electronics

How To Calculate Return On Equity?

Return on equity 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 Espey Mfg. & Electronics is:

4.1% = US$1.3m ÷ US$31m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.04 in profit.

Why Is ROE Important For Earnings Growth?

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

Espey Mfg. & Electronics' Earnings Growth And 4.1% ROE

It is hard to argue that Espey Mfg. & Electronics' ROE is much good in and of itself. Even compared to the average industry ROE of 7.5%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 11% seen by Espey Mfg. & Electronics over the last five years is not surprising. 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.

So, as a next step, we compared Espey Mfg. & Electronics' 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 4.4% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Espey Mfg. & Electronics fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Espey Mfg. & Electronics Making Efficient Use Of Its Profits?

With a three-year median payout ratio as high as 101%,Espey Mfg. & Electronics' shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Paying a dividend higher than reported profits is not a sustainable move. Our risks dashboard should have the 4 risks we have identified for Espey Mfg. & Electronics.

In addition, Espey Mfg. & Electronics 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 would have a hard think before deciding on any investment action concerning Espey Mfg. & Electronics. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Espey Mfg. & Electronics' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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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