Is The Market Rewarding FutureFuel Corp. (NYSE:FF) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?
FutureFuel (NYSE:FF) has had a rough month with its share price down 9.4%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study FutureFuel's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for FutureFuel
How To 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 FutureFuel is:
8.1% = US$23m ÷ US$279m (Based on the trailing twelve months to September 2022).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.08 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
FutureFuel's Earnings Growth And 8.1% ROE
On the face of it, FutureFuel's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 16%. Given the circumstances, the significant decline in net income by 11% seen by FutureFuel over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared FutureFuel's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 13% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about FutureFuel's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is FutureFuel Making Efficient Use Of Its Profits?
Despite having a normal three-year median payout ratio of 46% (where it is retaining 54% of its profits), FutureFuel has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Moreover, FutureFuel has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
Summary
Overall, we have mixed feelings about FutureFuel. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 3 risks we have identified for FutureFuel visit our risks dashboard for free.
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.
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