FRoSTA's (FRA:NLM) stock is up by a considerable 21% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on FRoSTA's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for FRoSTA
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for FRoSTA is:
12% = €23m ÷ €189m (Based on the trailing twelve months to June 2022).
The 'return' refers to a company's earnings over the last year. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.12.
What Has ROE Got To Do With 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. 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 FRoSTA's Earnings Growth And 12% ROE
To start with, FRoSTA's ROE looks acceptable. On comparing with the average industry ROE of 8.6% the company's ROE looks pretty remarkable. Yet, FRoSTA has posted measly growth of 3.8% over the past five years. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.
We then compared FRoSTA's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 5.2% in the same period, which is a bit concerning.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about FRoSTA's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is FRoSTA Using Its Retained Earnings Effectively?
Despite having a normal three-year median payout ratio of 45% (or a retention ratio of 55% over the past three years, FRoSTA has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
In addition, FRoSTA has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
Overall, we feel that FRoSTA certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 1 risk we have identified for FRoSTA visit our risks dashboard for free.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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