Federal Signal's (NYSE:FSS) stock is up by a considerable 8.8% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Federal Signal's ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
Return on equity 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 Federal Signal is:
15% = US$146m ÷ US$956m (Based on the trailing twelve months to September 2023).
The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.15.
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
To start with, Federal Signal's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 15%. This probably goes some way in explaining Federal Signal's moderate 5.5% growth over the past five years amongst other factors.
Next, on comparing with the industry net income growth, we found that Federal Signal's reported growth was lower than the industry growth of 9.0% over the last few years, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for FSS? You can find out in our latest intrinsic value infographic research report.
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.
Additionally, Federal Signal has paid dividends over a period of nine 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. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
In total, we are pretty happy with Federal Signal's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.