Fortive's (NYSE:FTV) stock up by 4.6% 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 Fortive's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Fortive is:
18% = US$1.7b ÷ US$9.3b (Based on the trailing twelve months to October 2021).
The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.18 in profit.
What Has ROE Got To Do With 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Fortive's Earnings Growth And 18% ROE
To begin with, Fortive seems to have a respectable ROE. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. Despite this, Fortive's five year net income growth was quite low averaging at only 4.3%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.
We then compared Fortive's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 8.5% in the same period, which is a bit concerning.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is FTV worth today? The intrinsic value infographic in our free research report helps visualize whether FTV is currently mispriced by the market.
Is Fortive Efficiently Re-investing Its Profits?
Fortive has a low three-year median payout ratio of 9.3% (meaning, the company keeps the remaining 91% of profits) which means that the company is retaining more of its earnings. However, the low earnings growth number doesn't reflect this as high growth usually follows high profit retention. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Moreover, Fortive has been paying dividends for five years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 9.7%. Regardless, Fortive's ROE is speculated to decline to 12% despite there being no anticipated change in its payout ratio.
In total, it does look like Fortive has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.