Declining Stock and Decent Financials: Is The Market Wrong About Omega Flex, Inc. (NASDAQ:OFLX)?
Omega Flex (NASDAQ:OFLX) has had a rough three months with its share price down 24%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Omega Flex's ROE in this article.
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.
Check out our latest analysis for Omega Flex
How Do You 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 Omega Flex is:
24% = US$19m ÷ US$80m (Based on the trailing twelve months to March 2024).
The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.24 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.
Omega Flex's Earnings Growth And 24% ROE
First thing first, we like that Omega Flex has an impressive ROE. Secondly, even when compared to the industry average of 14% the company's ROE is quite impressive. However, for some reason, the higher returns aren't reflected in Omega Flex's meagre five year net income growth average of 4.8%. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
As a next step, we compared Omega Flex's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 8.9% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Omega Flex is trading on a high P/E or a low P/E, relative to its industry.
Is Omega Flex Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 52% (or a retention ratio of 48%), most of Omega Flex's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.
Additionally, Omega Flex has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.
Summary
Overall, we feel that Omega Flex certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return.
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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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com