Do Fundamentals Have Any Role To Play In Driving Fernheizwerk Neukölln Aktiengesellschaft's (FRA:FHW) Stock Up Recently?

Fernheizwerk Neukölln's (FRA:FHW) stock up by 2.6% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Fernheizwerk Neukölln's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Fernheizwerk Neukölln

How Do You Calculate Return On Equity?

Return on equity 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 Fernheizwerk Neukölln is:

16% = €9.0m ÷ €57m (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.16 in profit.

Why Is ROE Important For 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 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.

A Side By Side comparison of Fernheizwerk Neukölln's Earnings Growth And 16% ROE

At first glance, Fernheizwerk Neukölln seems to have a decent ROE. On comparing with the average industry ROE of 6.2% the company's ROE looks pretty remarkable. However, for some reason, the higher returns aren't reflected in Fernheizwerk Neukölln's meagre five year net income growth average of 3.9%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared Fernheizwerk Neukölln's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 7.3% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Fernheizwerk Neukölln is trading on a high P/E or a low P/E, relative to its industry.

Is Fernheizwerk Neukölln Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 56% (or a retention ratio of 44%), most of Fernheizwerk Neukölln's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Moreover, Fernheizwerk Neukölln 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

Overall, we feel that Fernheizwerk Neukölln certainly does have some positive factors to consider. 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.

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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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