Freehold Royalties Ltd.'s (TSE:FRU) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 6.0% over the past three months, it is easy to disregard Freehold Royalties (TSE:FRU). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Freehold Royalties' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 Freehold Royalties

How Do You 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 Freehold Royalties is:

15% = CA$138m ÷ CA$936m (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.15.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Freehold Royalties' Earnings Growth And 15% ROE

At first glance, Freehold Royalties seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 17%. This certainly adds some context to Freehold Royalties' exceptional 67% net income growth seen over the past five years. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared Freehold Royalties' 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 42% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Freehold Royalties is trading on a high P/E or a low P/E, relative to its industry.

Is Freehold Royalties Making Efficient Use Of Its Profits?

Freehold Royalties has a significant three-year median payout ratio of 84%, meaning the company only retains 16% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Moreover, Freehold Royalties is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 61% over the next three years.

Summary

In total, we are pretty happy with Freehold Royalties' performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.