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Five Below (NASDAQ:FIVE) has had a rough three months with its share price down 44%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Five Below's ROE today.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Five Below is:
14% = US$254m ÷ US$1.8b (Based on the trailing twelve months to February 2025).
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.
Check out our latest analysis for Five Below
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.
Five Below's Earnings Growth And 14% ROE
To start with, Five Below's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 18%. This certainly adds some context to Five Below's moderate 14% net income growth seen over the past five years.
We then performed a comparison between Five Below's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 14% in the same 5-year period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for FIVE? You can find out in our latest intrinsic value infographic research report.