Want to participate in a short research study? Help shape the future of investing tools and earn a $40 gift card!
F5 Networks (NASDAQ:FFIV) has had a great run on the share market with its stock up by a significant 22% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on F5 Networks' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 F5 Networks is:
17% = US$341m ÷ US$2.0b (Based on the trailing twelve months to March 2020).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.17 in profit.
What Has ROE Got To Do With 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. 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.
F5 Networks' Earnings Growth And 17% ROE
To start with, F5 Networks' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 6.1%. Despite this, F5 Networks' five year net income growth was quite low averaging at only 4.8%. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
As a next step, we compared F5 Networks' 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 5.0% in the same period.
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. Has the market priced in the future outlook for FFIV? You can find out in our latest intrinsic value infographic research report.
Is F5 Networks Efficiently Re-investing Its Profits?
F5 Networks doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This doesn't explain the low earnings growth number that we discussed above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Overall, we are quite pleased with F5 Networks' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.