Flavor Full Foods (GTSM:1260) has had a rough three months with its share price down 1.4%. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. In this article, we decided to focus on Flavor Full Foods' ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You Calculate Return On Equity?
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 Flavor Full Foods is:
1.5% = NT$28m ÷ NT$1.9b (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. That means that for every NT$1 worth of shareholders' equity, the company generated NT$0.01 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
Flavor Full Foods' Earnings Growth And 1.5% ROE
It is hard to argue that Flavor Full Foods' ROE is much good in and of itself. Even compared to the average industry ROE of 11%, the company's ROE is quite dismal. For this reason, Flavor Full Foods' five year net income decline of 5.0% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
However, when we compared Flavor Full Foods' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.3% in the same period. This is quite worrisome.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Flavor Full Foods''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Flavor Full Foods Using Its Retained Earnings Effectively?
Flavor Full Foods' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 58% (or a retention ratio of 42%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 5 risks we have identified for Flavor Full Foods by visiting our risks dashboard for free on our platform here.
Additionally, Flavor Full Foods has paid dividends over a period of eight years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.
Overall, we would be extremely cautious before making any decision on Flavor Full Foods. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. 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 Flavor Full Foods' 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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