Are Robust Financials Driving The Recent Rally In Eltek Ltd.'s (NASDAQ:ELTK) Stock?

Eltek (NASDAQ:ELTK) has had a great run on the share market with its stock up by a significant 21% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Eltek's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 Eltek

How Is ROE Calculated?

The formula for return on equity is:

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

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

27% = US$2.2m ÷ US$8.3m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.27.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Eltek's Earnings Growth And 27% ROE

Firstly, we acknowledge that Eltek has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 9.7% which is quite remarkable. Under the circumstances, Eltek's considerable five year net income growth of 24% was to be expected.

Next, on comparing with the industry net income growth, we found that Eltek's growth is quite high when compared to the industry average growth of 10% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Eltek is trading on a high P/E or a low P/E, relative to its industry.

Is Eltek Efficiently Re-investing Its Profits?

Conclusion

In total, we are pretty happy with Eltek's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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 1 risk we have identified for Eltek 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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