It is hard to get excited after looking at Filtronic's (LON:FTC) recent performance, when its stock has declined 10% over the past three months. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Filtronic'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.
How To Calculate Return On Equity?
ROE 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 Filtronic is:
0.6% = UK£60k ÷ UK£9.4m (Based on the trailing twelve months to May 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.01 in profit.
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. 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 Filtronic's Earnings Growth And 0.6% ROE
As you can see, Filtronic's ROE looks pretty weak. Even compared to the average industry ROE of 14%, the company's ROE is quite dismal. Thus, the low net income growth of 4.9% seen by Filtronic over the past five years could probably be the result of it having a lower ROE.
We then compared Filtronic's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 34% in the same period, which is a bit concerning.
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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Filtronic fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Filtronic Making Efficient Use Of Its Profits?
Filtronic doesn't pay any dividend, which means that it is retaining all of its earnings. However, there's only been very little earnings growth to show for it. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
In total, we're a bit ambivalent about Filtronic's performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 2 risks we have identified for Filtronic.
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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.