Retail Food Group Limited's (ASX:RFG) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?
Retail Food Group's's (ASX:RFG) stock is up by a considerable 74% over the past month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Retail Food Group's ROE.
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.
See our latest analysis for Retail Food Group
How Is ROE Calculated?
Return on equity 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 Retail Food Group is:
8.8% = AU$16m ÷ AU$185m (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 A$1 worth of shareholders' equity, the company generated A$0.09 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. 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.
A Side By Side comparison of Retail Food Group's Earnings Growth And 8.8% ROE
When you first look at it, Retail Food Group's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 8.8%, so we won't completely dismiss the company. But then again, Retail Food Group's five year net income shrunk at a rate of 53%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.
That being said, we compared Retail Food Group'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 10% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Retail Food Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Retail Food Group Efficiently Re-investing Its Profits?
Retail Food Group doesn't pay any dividend, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Conclusion
On the whole, we feel that the performance shown by Retail Food Group can be open to many interpretations. 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. Our risks dashboard would have the 4 risks we have identified for Retail Food Group.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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