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Frontier Developments' (LON:FDEV) stock is up by a considerable 19% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Frontier Developments' ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To 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 Frontier Developments is:
19% = UK£18m ÷ UK£96m (Based on the trailing twelve months to November 2020).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.19 in profit.
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. 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.
A Side By Side comparison of Frontier Developments' Earnings Growth And 19% ROE
To start with, Frontier Developments' ROE looks acceptable. Especially when compared to the industry average of 4.4% the company's ROE looks pretty impressive. Probably as a result of this, Frontier Developments was able to see an impressive net income growth of 32% over the last five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.
We then performed a comparison between Frontier Developments' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 37% in the same period.
Earnings growth is a huge factor in stock valuation. 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 Frontier Developments''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Frontier Developments Making Efficient Use Of Its Profits?
In total, we are pretty happy with Frontier Developments' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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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