FirstService's (TSE:FSV) stock is up by a considerable 11% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on FirstService's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for FirstService

How Is ROE Calculated?

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 FirstService is:

10% = US$161m ÷ US$1.6b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.10 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

A Side By Side comparison of FirstService's Earnings Growth And 10% ROE

At first glance, FirstService's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 10.0%, we may spare it some thought. Moreover, we are quite pleased to see that FirstService's net income grew significantly at a rate of 41% over the last five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that FirstService's growth is quite high when compared to the industry average growth of 14% in the same period, which is great 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. This then helps them determine if the stock is placed for a bright or bleak future. Is FirstService fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is FirstService Efficiently Re-investing Its Profits?

FirstService has a three-year median payout ratio of 30% (where it is retaining 70% of its income) which is not too low or not too high. So it seems that FirstService is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, FirstService is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 19% over the next three years. As a result, the expected drop in FirstService's payout ratio explains the anticipated rise in the company's future ROE to 18%, over the same period.

Summary

On the whole, we do feel that FirstService has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable 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 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.