Flowtech Fluidpower plc's (LON:FLO) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

By
Simply Wall St
Published
May 18, 2022
AIM:FLO
Source: Shutterstock

Most readers would already be aware that Flowtech Fluidpower's (LON:FLO) stock increased significantly by 13% over the past week. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Particularly, we will be paying attention to Flowtech Fluidpower'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Flowtech Fluidpower

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 Flowtech Fluidpower is:

2.4% = UK£2.1m ÷ UK£88m (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.02 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Flowtech Fluidpower's Earnings Growth And 2.4% ROE

It is hard to argue that Flowtech Fluidpower's ROE is much good in and of itself. Even when compared to the industry average of 19%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 36% seen by Flowtech Fluidpower was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared Flowtech Fluidpower's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 11% in the same period. This is quite worrisome.

past-earnings-growth
AIM:FLO Past Earnings Growth May 18th 2022

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Flowtech Fluidpower is trading on a high P/E or a low P/E, relative to its industry.

Is Flowtech Fluidpower Making Efficient Use Of Its Profits?

Flowtech Fluidpower'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 58% (or a retention ratio of 42%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

Moreover, Flowtech Fluidpower has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 26% over the next three years.

Conclusion

On the whole, Flowtech Fluidpower's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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