Is The Market Rewarding The Foschini Group Limited (JSE:TFG) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

It is hard to get excited after looking at Foschini Group's (JSE:TFG) recent performance, when its stock has declined 13% over the past three months. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Foschini Group's ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Foschini Group

How To Calculate Return On Equity?

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 Foschini Group is:

12% = R2.8b ÷ R23b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ZAR1 of shareholders' capital it has, the company made ZAR0.12 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. 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. 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.

Foschini Group's Earnings Growth And 12% ROE

When you first look at it, Foschini Group's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 12%, we may spare it some thought. Having said that, Foschini Group has shown a meagre net income growth of 2.1% over the past five years. Remember, the company's ROE is not particularly great to begin with. Hence, this does provide some context to low earnings growth seen by the company.

We then compared Foschini Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 13% in the same 5-year period, which is a bit concerning.

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. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Foschini Group is trading on a high P/E or a low P/E, relative to its industry.

Is Foschini Group Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 35% (implying that the company retains the remaining 65% of its income), Foschini Group's earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Foschini Group has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 40%. Accordingly, forecasts suggest that Foschini Group's future ROE will be 14% which is again, similar to the current ROE.

Conclusion

In total, we're a bit ambivalent about Foschini Group's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

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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.