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It is hard to get excited after looking at FFI Holdings' (ASX:FFI) recent performance, when its stock has declined 5.7% over the past week. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on FFI Holdings' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
Return on equity 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 FFI Holdings is:
9.7% = AU$3.6m ÷ AU$37m (Based on the trailing twelve months to December 2019).
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$0.10.
Why Is ROE Important For 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
FFI Holdings' Earnings Growth And 9.7% ROE
On the face of it, FFI Holdings' ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 7.5% doesn't go unnoticed by us. Consequently, this likely laid the ground for the decent growth of 5.5% seen over the past five years by FFI Holdings. 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.
Next, on comparing with the industry net income growth, we found that the growth figure reported by FFI Holdings compares quite favourably to the industry average, which shows a decline of 0.5% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 FFI Holdings is trading on a high P/E or a low P/E, relative to its industry.
Is FFI Holdings Making Efficient Use Of Its Profits?
FFI Holdings has a significant three-year median payout ratio of 85%, meaning that it is left with only 15% 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, FFI Holdings 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.
In total, it does look like FFI Holdings has some positive aspects to its business. Namely, its significant earnings growth, to which its moderate rate of return likely contributed. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of FFI Holdings' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.
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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. Thank you for reading.