Flight Centre Travel Group Limited's (ASX:FLT) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Most readers would already be aware that Flight Centre Travel Group's (ASX:FLT) stock increased significantly by 10% over the past month. 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. In this article, we decided to focus on Flight Centre Travel Group'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Flight Centre Travel Group

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Flight Centre Travel Group is:

4.2% = AU$47m ÷ AU$1.1b (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.04.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

Flight Centre Travel Group's Earnings Growth And 4.2% ROE

On the face of it, Flight Centre Travel Group's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 6.9% either. Given the circumstances, the significant decline in net income by 29% seen by Flight Centre Travel Group over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

As a next step, we compared Flight Centre Travel Group's performance with the industry and found thatFlight Centre Travel Group's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 5.4% in the same period, which is a slower than the company.

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. Is FLT fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Flight Centre Travel Group Efficiently Re-investing Its Profits?

Flight Centre Travel Group has a high three-year median payout ratio of 78% (that is, it is retaining 22% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 2 risks we have identified for Flight Centre Travel Group.

Moreover, Flight Centre Travel Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 50% over the next three years. As a result, the expected drop in Flight Centre Travel Group's payout ratio explains the anticipated rise in the company's future ROE to 22%, over the same period.

Summary

Overall, we would be extremely cautious before making any decision on Flight Centre Travel Group. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.