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Should Weakness in Finning International Inc.'s (TSE:FTT) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

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It is hard to get excited after looking at Finning International's (TSE:FTT) recent performance, when its stock has declined 3.3% over the past week. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Finning International's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Finning International

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 Finning International is:

11% = CA$248m ÷ CA$2.2b (Based on the trailing twelve months to March 2021).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.11 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Finning International's Earnings Growth And 11% ROE

To begin with, Finning International seems to have a respectable ROE. Yet, the fact that the company's ROE is lower than the industry average of 15% does temper our expectations. That being the case, the significant five-year 38% net income growth reported by Finning International comes as a pleasant surprise. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.

We then compared Finning International's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 16% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Finning International's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Finning International Efficiently Re-investing Its Profits?

Finning International has a significant three-year median payout ratio of 55%, meaning the company only retains 45% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Moreover, Finning International 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

Overall, we feel that Finning International certainly does have some positive factors to consider. Especially the substantial growth in earnings backed by a decent ROE. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.

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

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