Finning International (TSE:FTT) has had a rough month with its share price down 6.9%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Finning International's ROE.
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.
How To Calculate Return On Equity?
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 Finning International is:
17% = CA$385m ÷ CA$2.3b (Based on the trailing twelve months to March 2022).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.17 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Finning International's Earnings Growth And 17% ROE
At first glance, Finning International seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 23% does temper our expectations. However, the moderate 15% net income growth seen by Finning International over the past five years is definitely a positive. So, there might be other aspects that are positively influencing earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also provides some context to the earnings growth seen by the company.
We then performed a comparison between Finning International's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 18% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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 Finning International fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Finning International Making Efficient Use Of Its Profits?
Finning International has a significant three-year median payout ratio of 54%, meaning that it is left with only 46% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.
Moreover, Finning International 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.
On the whole, we do feel that Finning International has some positive attributes. Especially the substantial growth in earnings backed by a decent ROE. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.
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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.