Could The Market Be Wrong About Formula Systems (1985) Ltd. (TLV:FORTY) Given Its Attractive Financial Prospects?

With its stock down 10% over the past three months, it is easy to disregard Formula Systems (1985) (TLV:FORTY). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Formula Systems (1985)'s ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Formula Systems (1985)

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Formula Systems (1985) is:

13% = US$165m ÷ US$1.2b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ₪1 of its shareholder's investments, the company generates a profit of ₪0.13.

Why Is ROE Important For Earnings Growth?

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

Formula Systems (1985)'s Earnings Growth And 13% ROE

To begin with, Formula Systems (1985) seems to have a respectable ROE. Even when compared to the industry average of 16% the company's ROE looks quite decent. This probably goes some way in explaining Formula Systems (1985)'s moderate 19% growth over the past five years amongst other factors.

As a next step, we compared Formula Systems (1985)'s net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 17% 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. 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 Formula Systems (1985) is trading on a high P/E or a low P/E, relative to its industry.

Is Formula Systems (1985) Making Efficient Use Of Its Profits?

Formula Systems (1985) has a healthy combination of a moderate three-year median payout ratio of 33% (or a retention ratio of 67%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Moreover, Formula Systems (1985) is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

In total, we are pretty happy with Formula Systems (1985)'s 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.

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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.