F&M Co.,Ltd.'s (TYO:4771) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Most readers would already be aware that F&MLtd's (TYO:4771) stock increased significantly by 14% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on F&MLtd's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for F&MLtd

How To 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 F&MLtd is:

11% = JP¥878m ÷ JP¥7.7b (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. That means that for every ¥1 worth of shareholders' equity, the company generated ¥0.11 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 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.

F&MLtd's Earnings Growth And 11% ROE

To start with, F&MLtd's ROE looks acceptable. Especially when compared to the industry average of 7.5% the company's ROE looks pretty impressive. However, we are curious as to how the high returns still resulted in flat growth for F&MLtd in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared F&MLtd's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 6.0% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 F&MLtd is trading on a high P/E or a low P/E, relative to its industry.

Is F&MLtd Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 39% (meaning the company retains61% of profits) in the last three-year period, F&MLtd's earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, F&MLtd has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

Overall, we feel that F&MLtd certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of F&MLtd's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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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