Essentra plc's (LON:ESNT) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?
Most readers would already be aware that Essentra's (LON:ESNT) stock increased significantly by 13% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Essentra's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Essentra
How To 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 Essentra is:
1.0% = UK£6.3m ÷ UK£631m (Based on the trailing twelve months to December 2020).
The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.01 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Essentra's Earnings Growth And 1.0% ROE
It is quite clear that Essentra's ROE is rather low. Even when compared to the industry average of 9.9%, the ROE figure is pretty disappointing. Although, we can see that Essentra saw a modest net income growth of 8.8% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Essentra's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.0%.
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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for ESNT? You can find out in our latest intrinsic value infographic research report.
Is Essentra Efficiently Re-investing Its Profits?
Essentra has a very high three-year median payout ratio of 152% suggesting that the company's shareholders are getting paid from more than just the company's earnings. Still the company's earnings have grown respectably. Although, the high payout ratio is certainly something we would keep an eye on if the company is not able to keep up its growth, or if business deteriorates. Our risks dashboard should have the 4 risks we have identified for Essentra.
Moreover, Essentra is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 33% over the next three years.
Summary
Overall, we have mixed feelings about Essentra. While the company has posted impressive earnings growth, its poor ROE and low earnings retention makes us doubtful if that growth could continue, if by any chance the business is faced with any sort of risk. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
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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