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Most readers would already be aware that FRP Holdings' (NASDAQ:FRPH) stock increased significantly by 20% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, 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. In this article, we decided to focus on FRP Holdings' ROE.
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for FRP Holdings is:
2.3% = US$8.8m ÷ US$392m (Based on the trailing twelve months to December 2019).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.02 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learnt 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. 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.
A Side By Side comparison of FRP Holdings' Earnings Growth And 2.3% ROE
As you can see, FRP Holdings' ROE looks pretty weak. Even compared to the average industry ROE of 6.0%, the company's ROE is quite dismal. However, the moderate 8.4% net income growth seen by FRP Holdings over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared FRP Holdings' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 8.4% in the same period.
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. Doing so will help them establish if the stock's future looks promising or ominous. Is FRP Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is FRP Holdings Using Its Retained Earnings Effectively?
Given that FRP Holdings doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
On the whole, we do feel that FRP Holdings has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth.
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.
To know the 1 risk we have identified for FRP Holdings visit our risks dashboard for free.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.