Most readers would already know that Franchise Brands' (LON:FRAN) stock increased by 9.5% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Franchise Brands' ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Franchise Brands is:
9.7% = UK£2.7m ÷ UK£28m (Based on the trailing twelve months to December 2019).
The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.10 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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.
Franchise Brands' Earnings Growth And 9.7% ROE
To begin with, Franchise Brands seems to have a respectable ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 16%. That being the case, the significant five-year 40% net income growth reported by Franchise Brands comes as a pleasant surprise. Therefore, there could be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.
Next, on comparing with the industry net income growth, we found that Franchise Brands' growth is quite high when compared to the industry average growth of 30% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is FRAN fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Franchise Brands Using Its Retained Earnings Effectively?
Franchise Brands' ' three-year median payout ratio is on the lower side at 23% implying that it is retaining a higher percentage (77%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Besides, Franchise Brands has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders.
On the whole, we feel that Franchise Brands' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 1 risk we have identified for Franchise Brands by visiting our risks dashboard for free on our platform here.
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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