Freightways' (NZSE:FRE) stock up by 3.8% over the past month. 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 Freightways' ROE in this article.
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Freightways is:
15% = NZ$47m ÷ NZ$317m (Based on the trailing twelve months to June 2020).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.15 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Freightways' Earnings Growth And 15% ROE
To begin with, Freightways seems to have a respectable ROE. On comparing with the average industry ROE of 9.5% the company's ROE looks pretty remarkable. Yet, Freightways has posted measly growth of 4.7% over the past five years. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.
We then compared Freightways' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 8.4% 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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Freightways''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Freightways Making Efficient Use Of Its Profits?
Freightways has a three-year median payout ratio of 74% (implying that it keeps only 26% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.
Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 79% of its profits over the next three years. Still, forecasts suggest that Freightways' future ROE will rise to 21% even though the the company's payout ratio is not expected to change by much.
In total, it does look like Freightways 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. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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