Are FirstFarms A/S' (CPH:FFARMS) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

With its stock down 3.1% over the past three months, it is easy to disregard FirstFarms (CPH:FFARMS). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study FirstFarms' ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for FirstFarms

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 FirstFarms is:

4.7% = kr.22m ÷ kr.480m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every DKK1 of its shareholder's investments, the company generates a profit of DKK0.05.

Why Is ROE Important For Earnings Growth?

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

FirstFarms' Earnings Growth And 4.7% ROE

On the face of it, FirstFarms' ROE is not much to talk about. Next, when compared to the average industry ROE of 8.0%, the company's ROE leaves us feeling even less enthusiastic. However, we we're pleasantly surprised to see that FirstFarms grew its net income at a significant rate of 73% in the last five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared FirstFarms' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 6.4%.

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. 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 FirstFarms is trading on a high P/E or a low P/E, relative to its industry.

Is FirstFarms Using Its Retained Earnings Effectively?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. This is likely what's driving the high earnings growth number discussed above.

Summary

In total, it does look like FirstFarms has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 3 risks we have identified for FirstFarms by visiting our risks dashboard for free on our platform here.

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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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