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FormFactor, Inc.'s (NASDAQ:FORM) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

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·3 min read
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FormFactor (NASDAQ:FORM) has had a great run on the share market with its stock up by a significant 7.3% over the last week. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on FormFactor's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for FormFactor

How Do You Calculate Return On Equity?

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 FormFactor is:

10% = US$84m ÷ US$816m (Based on the trailing twelve months to December 2021).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.10 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

FormFactor's Earnings Growth And 10% ROE

At first glance, FormFactor seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 18% does temper our expectations. Still, we can see that FormFactor has seen a remarkable net income growth of 28% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently. Bear in mind, the company does have a respectable ROE. It is just that the industry ROE is higher. So this also does lend some color to the high earnings growth seen by the company.

As a next step, we compared FormFactor's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 19%.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. 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 FormFactor fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is FormFactor Using Its Retained Earnings Effectively?

FormFactor doesn't pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.

Summary

On the whole, we feel that FormFactor's performance has been quite good. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.