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Most readers would already be aware that FirstGroup's (LON:FGP) stock increased significantly by 14% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study FirstGroup's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for FirstGroup
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 FirstGroup is:
14% = UK£100m ÷ UK£701m (Based on the trailing twelve months to September 2024).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.14 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
FirstGroup's Earnings Growth And 14% ROE
To begin with, FirstGroup seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. Probably as a result of this, FirstGroup was able to see an impressive net income growth of 76% over the last five years. However, there could also 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.
We then compared FirstGroup's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 31% in the same 5-year period.
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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about FirstGroup's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.