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FFI Holdings (ASX:FFI) has had a great run on the share market with its stock up by a significant 12% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to FFI Holdings' ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for FFI Holdings is:
9.1% = AU$3.4m ÷ AU$38m (Based on the trailing twelve months to June 2020).
The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.09.
Why Is ROE Important For 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.
FFI Holdings' Earnings Growth And 9.1% ROE
On the face of it, FFI Holdings' ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 4.7% which we definitely can't overlook. This certainly adds some context to FFI Holdings' moderate 11% net income growth seen over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence there might be some other aspects that are causing earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.
Given that the industry shrunk its earnings at a rate of 1.3% in the same period, the net income growth of the company is quite impressive.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is FFI Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is FFI Holdings Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 91% (or a retention ratio of 8.7%) for FFI Holdings suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Besides, FFI Holdings has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.
In total, it does look like FFI Holdings has some positive aspects to its business. Specifically, its decent ROE which likely contributed to the growth in earnings. Bear in mind, the company reinvests little to none of its profits, which means that investors aren't necessarily reaping the full benefits of the decent rate of return. Up till now, we've only made a short study of the company's growth data. To gain further insights into FFI Holdings' past profit growth, check out this visualization of past earnings, revenue and cash flows.
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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