Federal Signal's (NYSE:FSS) stock up by 5.1% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Federal Signal's ROE in this article.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Federal Signal is:
16% = US$103m ÷ US$655m (Based on the trailing twelve months to June 2020).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.16.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Federal Signal's Earnings Growth And 16% ROE
To start with, Federal Signal's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 11%. This certainly adds some context to Federal Signal's decent 18% net income growth seen over the past five years.
Next, on comparing with the industry net income growth, we found that Federal Signal's growth is quite high when compared to the industry average growth of 10% in the same period, which is great to see.
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. 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 has a low three-year median payout ratio of 20%, meaning that the company retains the remaining 80% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Besides, Federal Signal has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.
Overall, we are quite pleased with Federal Signal's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.
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