Focusrite (LON:TUNE) has had a great run on the share market with its stock up by a significant 18% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Focusrite’s ROE.
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 Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Focusrite is:
24% = UK£25m ÷ UK£105m (Based on the trailing twelve months to August 2022).
The ‘return’ is the income the business earned over the last year. So, this means that for every £1 of its shareholder’s investments, the company generates a profit of £0.24.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned 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. 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.
A Side By Side comparison of Focusrite’s Earnings Growth And 24% ROE
First thing first, we like that Focusrite has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 11% also doesn’t go unnoticed by us. So, the substantial 25% net income growth seen by Focusrite over the past five years isn’t overly surprising.
When you consider the fact that the industry earnings have shrunk at a rate of 4.9% in the same period, the company’s net income growth is pretty remarkable.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Focusrite fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Focusrite Efficiently Re-investing Its Profits?
Focusrite’s three-year median payout ratio to shareholders is 14%, which is quite low. This implies that the company is retaining 86% of its profits. So it looks like Focusrite is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Moreover, Focusrite is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. Based on the latest analysts’ estimates, we found that the company’s future payout ratio over the next three years is expected to hold steady at 14%. Accordingly, forecasts suggest that Focusrite’s future ROE will be 20% which is again, similar to the current ROE.
On the whole, we feel that Focusrite’s performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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