Frasers Group's (LON:FRAS) stock is up by 4.2% over the past three months. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. Specifically, we decided to study Frasers Group's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Frasers Group
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 Frasers Group is:
9.0% = UK£120m ÷ UK£1.3b (Based on the trailing twelve months to October 2020).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.09 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
A Side By Side comparison of Frasers Group's Earnings Growth And 9.0% ROE
When you first look at it, Frasers Group's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 11%, we may spare it some thought. Having said that, Frasers Group's five year net income decline rate was 27%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 1.9% in the same period, we found that Frasers Group's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
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 Frasers Group is trading on a high P/E or a low P/E, relative to its industry.
Is Frasers Group Efficiently Re-investing Its Profits?
Frasers Group doesn't pay any dividend, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Overall, we have mixed feelings about Frasers Group. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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