Are Strong Financial Prospects The Force That Is Driving The Momentum In Five Below, Inc.'s NASDAQ:FIVE) Stock?

Most readers would already be aware that Five Below's (NASDAQ:FIVE) stock increased significantly by 17% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Five Below's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Five Below

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 Five Below is:

17% = US$281m ÷ US$1.6b (Based on the trailing twelve months to August 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.17 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

Five Below's Earnings Growth And 17% ROE

To begin with, Five Below seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 20%. Consequently, this likely laid the ground for the decent growth of 17% seen over the past five years by Five Below.

We then performed a comparison between Five Below's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 20% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Five Below fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Five Below Using Its Retained Earnings Effectively?

Five Below doesn't pay any regular dividends, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.

Summary

On the whole, we feel that Five Below's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.