Franchise Brands plc's (LON:FRAN) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Franchise Brands' (LON:FRAN) stock is up by a considerable 14% over the past week. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Franchise Brands' ROE.

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.

View our latest analysis for Franchise Brands

How To 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 Franchise Brands is:

6.4% = UK£2.8m ÷ UK£44m (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 £0.06 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Franchise Brands' Earnings Growth And 6.4% ROE

When you first look at it, Franchise Brands' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 14% either. Despite this, surprisingly, Franchise Brands saw an exceptional 36% net income growth over the past five years. So, there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Franchise Brands' growth is quite high when compared to the industry average growth of 13% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Franchise Brands fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Franchise Brands Making Efficient Use Of Its Profits?

Franchise Brands' three-year median payout ratio is a pretty moderate 27%, meaning the company retains 73% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Franchise Brands is reinvesting its earnings efficiently.

Moreover, Franchise Brands is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 28%.

Conclusion

Overall, we feel that Franchise Brands certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.

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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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