Federal Signal Corporation's (NYSE:FSS) Stock Is Going Strong: Is the Market Following Fundamentals?

Federal Signal (NYSE:FSS) has had a great run on the share market with its stock up by a significant 9.0% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Federal Signal's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Federal Signal

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Federal Signal is:

18% = US$202m ÷ US$1.1b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.18 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. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Federal Signal's Earnings Growth And 18% ROE

To start with, Federal Signal's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 15%. Probably as a result of this, Federal Signal was able to see a decent growth of 12% over the last five years.

As a next step, we compared Federal Signal'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 11% 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. What is FSS worth today? The intrinsic value infographic in our free research report helps visualize whether FSS is currently mispriced by the market.

Is Federal Signal Efficiently Re-investing Its Profits?

Federal Signal's three-year median payout ratio to shareholders is 18% (implying that it retains 82% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Federal Signal 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

On the whole, we feel that Federal Signal's performance has been quite good. 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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.