Frontier Developments plc (LON:FDEV) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?

It is hard to get excited after looking at Frontier Developments' (LON:FDEV) recent performance, when its stock has declined 13% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Frontier Developments' ROE.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Frontier Developments

How Is ROE Calculated?

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 Frontier Developments is:

12% = UK£14m ÷ UK£113m (Based on the trailing twelve months to November 2021).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.12 in profit.

What Is The Relationship Between ROE And 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.

Frontier Developments' Earnings Growth And 12% ROE

To start with, Frontier Developments' ROE looks acceptable. Even when compared to the industry average of 15% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 23% seen over the past five years by Frontier Developments. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

Next, on comparing Frontier Developments' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 23% 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. What is FDEV worth today? The intrinsic value infographic in our free research report helps visualize whether FDEV is currently mispriced by the market.

Is Frontier Developments Efficiently Re-investing Its Profits?

Frontier Developments doesn't pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.

Summary

In total, we are pretty happy with Frontier Developments' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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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.