FirstService Corporation's (TSE:FSV) Has Had A Decent Run On The Stock market: Are Fundamentals In The Driver's Seat?
Most readers would already know that FirstService's (TSE:FSV) stock increased by 8.3% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study FirstService's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for FirstService
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 FirstService is:
13% = US$110m ÷ US$853m (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.13.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
FirstService's Earnings Growth And 13% ROE
To begin with, FirstService seems to have a respectable ROE. Especially when compared to the industry average of 6.8% the company's ROE looks pretty impressive. For this reason, FirstService's five year net income decline of 29% raises the question as to why the high ROE didn't translate into earnings growth. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
So, as a next step, we compared FirstService's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 4.7% 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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about FirstService's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is FirstService Making Efficient Use Of Its Profits?
Despite having a normal three-year median payout ratio of 32% (where it is retaining 68% of its profits), FirstService has seen a decline in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
In addition, FirstService has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 19% over the next three years. The fact that the company's ROE is expected to rise to 20% over the same period is explained by the drop in the payout ratio.
Summary
In total, it does look like FirstService has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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. 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.
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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