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Will Weakness in Fabrinet's (NYSE:FN) Stock Prove Temporary Given Strong Fundamentals?

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Fabrinet (NYSE:FN) has had a rough month with its share price down 6.3%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Fabrinet's ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Fabrinet

How Do You 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 Fabrinet is:

12% = US$125m ÷ US$1.0b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.12.

Why Is ROE Important For Earnings Growth?

So far, we've learned 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.

Fabrinet's Earnings Growth And 12% ROE

To start with, Fabrinet's ROE looks acceptable. Especially when compared to the industry average of 9.9% the company's ROE looks pretty impressive. Probably as a result of this, Fabrinet was able to see a decent growth of 14% over the last five years.

As a next step, we compared Fabrinet's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.

past-earnings-growth
past-earnings-growth

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). Doing so will help them establish if the stock's future looks promising or ominous. Is FN fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Fabrinet Efficiently Re-investing Its Profits?

Fabrinet doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the decent earnings growth number that we discussed above.

Summary

In total, we are pretty happy with Fabrinet's 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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 editorial-team (at) simplywallst.com.