Does Fras-le S.A.'s (BVMF:FRAS3) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Most readers would already be aware that Fras-le's (BVMF:FRAS3) stock increased significantly by 54% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Fras-le's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Fras-le

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 Fras-le is:

4.1% = R$34m ÷ R$829m (Based on the trailing twelve months to March 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each R$1 of shareholders' capital it has, the company made R$0.04 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learnt that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Fras-le's Earnings Growth And 4.1% ROE

It is hard to argue that Fras-le's ROE is much good in and of itself. An industry comparison shows that the company's ROE is not much different from the industry average of 4.1% either. Therefore, the low net income growth of 2.5% seen by Fras-le over the past five years could probably be the result of it having a lower ROE.

We then compared Fras-le's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 3.6% in the same period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Fras-le is trading on a high P/E or a low P/E, relative to its industry.

Is Fras-le Efficiently Re-investing Its Profits?

Fras-le has a three-year median payout ratio of 68% (implying that it keeps only 32% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

In addition, Fras-le has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

Overall, we would be extremely cautious before making any decision on Fras-le. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. In brief, we think the company is risky and investors should think twice before making any final judgement on this company. To know the 4 risks we have identified for Fras-le visit our risks dashboard for free.

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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.