Does ForFarmers N.V.'s (AMS:FFARM) Weak Fundamentals Mean A Downturn In Its Stock Should Be Expected?

ForFarmers' (AMS:FFARM) stock up by 9.6% over the past three months. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. In this article, we decided to focus on ForFarmers' 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 ForFarmers

How Is ROE Calculated?

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 ForFarmers is:

7.5% = €28m ÷ €379m (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. That means that for every €1 worth of shareholders' equity, the company generated €0.07 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of ForFarmers' Earnings Growth And 7.5% ROE

On the face of it, ForFarmers' ROE is not much to talk about. However, its ROE is similar to the industry average of 8.2%, so we won't completely dismiss the company. But ForFarmers saw a five year net income decline of 11% over the past five years. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.

So, as a next step, we compared ForFarmers' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.1% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is ForFarmers fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is ForFarmers Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 53% (implying that 47% of the profits are retained), most of ForFarmers' profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 2 risks we have identified for ForFarmers visit our risks dashboard for free.

Additionally, ForFarmers has paid dividends over a period of four years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 50%. Still, forecasts suggest that ForFarmers' future ROE will rise to 10% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we would be extremely cautious before making any decision on ForFarmers. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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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