Could The Market Be Wrong About RF Industries, Ltd. (NASDAQ:RFIL) Given Its Attractive Financial Prospects?
It is hard to get excited after looking at RF Industries' (NASDAQ:RFIL) recent performance, when its stock has declined 11% over the past month. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to RF Industries' ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
Check out our latest analysis for RF Industries
How Do You 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 RF Industries is:
16% = US$6.2m ÷ US$40m (Based on the trailing twelve months to October 2021).
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 $0.16.
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. 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 RF Industries' Earnings Growth And 16% ROE
To begin with, RF Industries seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 14%. This certainly adds some context to RF Industries' exceptional 38% net income growth seen over the past five years. However, there could also be other drivers behind this 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.
As a next step, we compared RF Industries' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 16%.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 RF Industries is trading on a high P/E or a low P/E, relative to its industry.
Is RF Industries Using Its Retained Earnings Effectively?
While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. This is likely what's driving the high earnings growth number discussed above.
Conclusion
In total, we are pretty happy with RF Industries' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 4 risks we have identified for RF Industries by visiting our risks dashboard for free on our platform here.
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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.
