FLSmidth & Co. A/S' (CPH:FLS) Dismal Stock Performance Reflects Weak Fundamentals

It is hard to get excited after looking at FLSmidth's (CPH:FLS) recent performance, when its stock has declined 26% over the past three months. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to FLSmidth'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for FLSmidth

How Is ROE Calculated?

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 FLSmidth is:

3.6% = kr.374m ÷ kr.10b (Based on the trailing twelve months to December 2021).

The 'return' is the profit over the last twelve months. So, this means that for every DKK1 of its shareholder's investments, the company generates a profit of DKK0.04.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of FLSmidth's Earnings Growth And 3.6% ROE

When you first look at it, FLSmidth's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 12%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 12% seen by FLSmidth was probably the result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 1.6% in the same period, we found that FLSmidth's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is FLS fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is FLSmidth Using Its Retained Earnings Effectively?

FLSmidth's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 51% (or a retention ratio of 49%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 4 risks we have identified for FLSmidth by visiting our risks dashboard for free on our platform here.

Moreover, FLSmidth 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 43%. However, FLSmidth's ROE is predicted to rise to 9.4% despite there being no anticipated change in its payout ratio.

Summary

On the whole, FLSmidth's performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.