Federal Signal Corporation's (NYSE:FSS) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?
With its stock down 1.9% over the past three months, it is easy to disregard Federal Signal (NYSE:FSS). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Federal Signal's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Federal Signal
How Is ROE Calculated?
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 Federal Signal is:
14% = US$120m ÷ US$861m (Based on the trailing twelve months to December 2022).
The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.14 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. 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 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.
A Side By Side comparison of Federal Signal's Earnings Growth And 14% ROE
To start with, Federal Signal's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 13%. Consequently, this likely laid the ground for the decent growth of 6.2% seen over the past five years by Federal Signal.
Next, on comparing with the industry net income growth, we found that Federal Signal's reported growth was lower than the industry growth of 8.1% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 20% (implying that it retains 80% 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 nine years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 14% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
Conclusion
On the whole, we feel that Federal Signal'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. As a result, the decent growth in its earnings is not surprising. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
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