Most readers already know that Electrocomponents (LON: ECM) stock was up 4.4% over the past month. Since the market usually pays for a company’s long-term financial health, we decided to examine the company’s fundamentals to see if it could affect the market. Today we will pay particular attention to the ROE from Electrocomponents.
Return on Equity, or ROE, is an important factor to consider as a shareholder telling them how effectively their capital will be reinvested. In short, ROE shows the profit each dollar generates on its equity investment.
Check out our latest analysis for electrical components
How do you calculate the return on equity?
the Formula for return on equity is:
Return on Equity = Net Income (from continuing operations) ÷ Equity
Based on the formula above, the ROE for electrical components is:
14% = UK £ 126m ÷ UK £ 899m (based on the last 12 months through March 2021).
The “return” is the income that the company has earned over the past year. So that means that for every £ 1 of its shareholder’s investment, the company will make a profit of £ 0.14.
What is the Relationship Between ROE and Earnings Growth?
So far we have learned that the ROE measures how efficiently a company generates its profits. We now need to evaluate how much profit the company can reinvest or “keep” for future growth, which then gives us an idea of the company’s growth potential. In general, all other things being equal, companies with high ROE and retained earnings will grow faster than companies that do not share these attributes.
A side-by-side comparison of Electrocomponents earnings growth and 14% ROE
First of all, Electrocomponents’ ROE looks acceptable. In addition, the company’s ROE is the industry average of 14%. This certainly adds some context to Electrocomponents’ modest net profit growth of 17% over the past five years.
Next, when we compared it to industry net income growth, we found that Electrocomponents growth is quite high compared to the industry average of 7.3% over the same period, which is great to see.
Earnings growth is a big factor in stock valuation. It is important for an investor to know if the market has factored in the company’s expected earnings growth (or decline). That way, they can determine whether the future of the stock looks promising or ominous. If you are wondering about Electrocomponents’ valuation, check out this Price / Earnings Ratio versus Industry Rating.
Is Electrocomponents reinvesting its profits efficiently?
Electrocomponents has a 3 year median payout ratio of 46%, which means it keeps the remaining 54% of its profits. This suggests that the dividend is well covered, and given the company’s decent growth, it looks like management is efficiently reinvesting its profits.
Also, Electrocomponents has been paying dividends for at least ten years or more. This shows that the company is keen to share profits with its shareholders. When examining the latest analyst consensus data, we found that the company is expected to continue paying out around 39% of its earnings over the next three years. However, Electrocomponents’ ROE is expected to rise to 20%, although the payout ratio is not expected to change.
Overall, we are very satisfied with the performance of Electrocomponents. We particularly like the fact that the company is massively reinvesting in its business and doing so with high returns. Unsurprisingly, this has resulted in impressive earnings growth. We also examined the latest analyst forecasts and determined that the company’s earnings growth is likely to match the current growth rate. Are these analyst expectations based on broad industry expectations or company fundamentals? Click here to go to our analysts forecast page for the company.
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This article from Simply Wall St is of a general nature. We only provide comments based on historical data and analyst projections using an unbiased methodology, and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. Our goal is to provide you with long-term, focused analysis based on fundamentals. Note that our analysis may not take into account the latest company announcements or quality material, which may be sensitive to the price. Simply Wall St has no position in the stocks mentioned.
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