Are Eckoh plc's (LON:ECK) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

editorial-team@simplywallst.com (Simply Wall St)

Thu, Dec 21, 2023, 10:57 PM 4 min read

Eckoh (LON:ECK) has had a rough three months with its share price down 15%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Eckoh's ROE in this article.

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 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 Eckoh

How Is ROE Calculated?

The formula for ROE is:

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

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

8.4% = UK£3.7m ÷ UK£43m (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

A Side By Side comparison of Eckoh's Earnings Growth And 8.4% ROE

At first glance, Eckoh's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 14%. Although, we can see that Eckoh saw a modest net income growth of 16% over the past five years. So, the growth in the company's earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Eckoh's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 18% in the same period.

past-earnings-growth — AIM:ECK Past Earnings Growth December 22nd 2023

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). This then helps them determine if the stock is placed for a bright or bleak future. Is ECK fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Eckoh Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 59% (or a retention ratio of 41%) for Eckoh suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, Eckoh has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 38% over the next three years. As a result, the expected drop in Eckoh's payout ratio explains the anticipated rise in the company's future ROE to 16%, over the same period.

Conclusion

On the whole, we do feel that Eckoh has some positive attributes. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. The latest industry analyst forecasts show that the company is expected to maintain its current 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.