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Most readers would already be aware that Flowtech Fluidpower's (LON:FLO) stock increased significantly by 20% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Flowtech Fluidpower'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.
Check out our latest analysis for Flowtech Fluidpower
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 Flowtech Fluidpower is:
0.6% = UK£526k ÷ UK£88m (Based on the trailing twelve months to June 2021).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.01 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Flowtech Fluidpower's Earnings Growth And 0.6% ROE
It is hard to argue that Flowtech Fluidpower's ROE is much good in and of itself. Even when compared to the industry average of 13%, the ROE figure is pretty disappointing. For this reason, Flowtech Fluidpower's five year net income decline of 36% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
So, as a next step, we compared Flowtech Fluidpower's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.5% in the same period.
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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Flowtech Fluidpower's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.