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Falcon Minerals' (NASDAQ:FLMN) stock is up by a considerable 36% over the past week. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study Falcon Minerals' ROE in this article.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Falcon Minerals is:
5.9% = US$14m ÷ US$236m (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.06 in profit.
What Has ROE Got To Do With 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 Falcon Minerals' Earnings Growth And 5.9% ROE
On the face of it, Falcon Minerals' ROE is not much to talk about. Next, when compared to the average industry ROE of 14%, the company's ROE leaves us feeling even less enthusiastic. Given the circumstances, the significant decline in net income by 29% seen by Falcon Minerals over the last five years is not surprising. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.
However, when we compared Falcon Minerals' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 2.8% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Falcon Minerals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Falcon Minerals Using Its Retained Earnings Effectively?
With a three-year median payout ratio as high as 179%,Falcon Minerals' shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Its usually very hard to sustain dividend payments that are higher than reported profits. To know the 3 risks we have identified for Falcon Minerals visit our risks dashboard for free.
Additionally, Falcon Minerals started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 140% over the next three years.
On the whole, Falcon Minerals' performance is quite a big let-down. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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