Is Frontier Developments plc's (LON:FDEV) Latest Stock Performance A Reflection Of Its Financial Health?

Most readers would already be aware that Frontier Developments' (LON:FDEV) stock increased significantly by 26% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Frontier Developments' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See 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:

16% = UK£16m ÷ UK£97m (Based on the trailing twelve months to May 2020).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.16 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 16% ROE

At first glance, Frontier Developments seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 17%. This certainly adds some context to Frontier Developments' exceptional 34% net income growth seen over the past five years. We believe that there might also 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 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 34% in the same period.

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Frontier Developments''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Frontier Developments Making Efficient Use Of Its Profits?

Summary

Overall, we are quite pleased with Frontier Developments' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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. 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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