It is hard to get excited after looking at Fondia Oyj's (HEL:FONDIA) recent performance, when its stock has declined 6.5% over the past three months. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Specifically, we decided to study Fondia Oyj's ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Is ROE Calculated?
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 Fondia Oyj is:
5.8% = €357k ÷ €6.1m (Based on the trailing twelve months to December 2019).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.06 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learnt 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 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.
Fondia Oyj's Earnings Growth And 5.8% ROE
At first glance, Fondia Oyj's ROE doesn't look very promising. However, its ROE is similar to the industry average of 6.8%, so we won't completely dismiss the company. However, Fondia Oyj has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.
We then compared Fondia Oyj's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 36% in the same period, which is a bit concerning.
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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Fondia Oyj's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Fondia Oyj Using Its Retained Earnings Effectively?
Fondia Oyj has a very high three-year median payout ratio of 134% over the last last three years, which suggests that the company is dipping into more than just its earnings to pay its dividend. This does go some way in explaining the negligible earnings growth seen by Fondia Oyj. Its usually very hard to sustain dividend payments that are higher than reported profits. This is indicative of risk. To know the 4 risks we have identified for Fondia Oyj visit our risks dashboard for free.
In addition, Fondia Oyj only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 78% over the next three years. The fact that the company's ROE is expected to rise to 26% over the same period is explained by the drop in the payout ratio.
In total, we would have a hard think before deciding on any investment action concerning Fondia Oyj. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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. Thank you for reading.