FRoSTA Aktiengesellschaft's (FRA:NLM) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

FRoSTA (FRA:NLM) has had a rough month with its share price down 4.8%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to FRoSTA'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for FRoSTA

How Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for FRoSTA is:

14% = €25m ÷ €176m (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.14 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

FRoSTA's Earnings Growth And 14% ROE

At first glance, FRoSTA seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.1%. Given the circumstances, we can't help but wonder why FRoSTA saw little to no growth in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that FRoSTA's reported growth was a little less than the industry growth of0.6% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is FRoSTA fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is FRoSTA Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 55% (implying that the company keeps only 45% of its income) of its business to reinvest into its business), most of FRoSTA's profits are being paid to shareholders, which explains the absence of growth in earnings.

Moreover, FRoSTA 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.

Conclusion

In total, it does look like FRoSTA has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of FRoSTA's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.
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