Most readers would already be aware that Federal Signal's (NYSE:FSS) stock increased significantly by 16% 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.

Check out our latest analysis for Federal Signal

How To 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:

19% = US$213m ÷ US$1.1b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.19 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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 19% ROE

To begin with, Federal Signal seems to have a respectable ROE. On comparing with the average industry ROE of 15% the company's ROE looks pretty remarkable. This certainly adds some context to Federal Signal's decent 14% net income growth seen over the past five years.

Next, on comparing Federal Signal's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 15% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 17%, meaning that the company retains the remaining 83% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Additionally, Federal Signal has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 13% 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. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.