Flexsteel Industries, Inc.'s (NASDAQ:FLXS) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?
With its stock down 29% over the past three months, it is easy to disregard Flexsteel Industries (NASDAQ:FLXS). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Flexsteel Industries' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for Flexsteel Industries
How Do You Calculate Return On Equity?
ROE 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 Flexsteel Industries is:
14% = US$23m ÷ US$168m (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.14 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. 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.
Flexsteel Industries' Earnings Growth And 14% ROE
To start with, Flexsteel Industries' ROE looks acceptable. Yet, the fact that the company's ROE is lower than the industry average of 19% does temper our expectations. Further research shows that Flexsteel Industries' net income has shrunk at a rate of 49% over the last five years. Bear in mind, the company does have a high ROE. It is just that the industry ROE is higher. So there might be other reasons for the earnings to shrink. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
However, when we compared Flexsteel Industries' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 16% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Flexsteel Industries''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Flexsteel Industries Using Its Retained Earnings Effectively?
When we piece together Flexsteel Industries' low LTM (or last twelve month) payout ratio of 14% (where it is retaining 86% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.
In addition, Flexsteel Industries has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
Summary
On the whole, we do feel that Flexsteel Industries has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate 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. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 4 risks we have identified for Flexsteel Industries by visiting our risks dashboard for free on our platform here.
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.
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