Foot Locker (NYSE:FL) has had a great run on the share market with its stock up by a significant 8.9% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Foot Locker'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
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 Foot Locker is:
27% = US$913m ÷ US$3.3b (Based on the trailing twelve months to October 2021).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.27.
What Has ROE Got To Do With 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.
Foot Locker's Earnings Growth And 27% ROE
First thing first, we like that Foot Locker has an impressive ROE. Additionally, a comparison with the average industry ROE of 31% also portrays the company's ROE in a good light. However, for some reason, the higher returns aren't reflected in Foot Locker's meagre five year net income growth average of 3.2%.Despite this, Foot Locker's five year net income growth was quite low averaging at only 3.2%.Yet, Foot Locker has posted measly growth of 3.2% over the past five years. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Next, on comparing with the industry net income growth, we found that Foot Locker's reported growth was lower than the industry growth of 18% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for FL? You can find out in our latest intrinsic value infographic research report.
Is Foot Locker Using Its Retained Earnings Effectively?
Despite having a normal three-year median payout ratio of 29% (or a retention ratio of 71% over the past three years, Foot Locker has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
In addition, Foot Locker 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 24%. However, Foot Locker's future ROE is expected to decline to 17% despite there being not much change anticipated in the company's payout ratio.
On the whole, we do feel that Foot Locker has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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.