Ferretti (HKG:9638) has had a great run on the share market with its stock up by a significant 7.7% over the last week. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Ferretti's ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Ferretti

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 Ferretti is:

5.9% = €44m ÷ €748m (Based on the trailing twelve months to June 2022).

The 'return' is the yearly profit. Another way to think of that is that for every HK$1 worth of equity, the company was able to earn HK$0.06 in profit.

What Is The Relationship Between ROE And 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. 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.

A Side By Side comparison of Ferretti's Earnings Growth And 5.9% ROE

At first glance, Ferretti's ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 4.1% doesn't go unnoticed by us. This certainly adds some context to Ferretti's moderate 9.8% net income growth seen over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So there might well be other reasons for the earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

When you consider the fact that the industry earnings have shrunk at a rate of 9.0% in the same period, the company's net income growth is pretty remarkable.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Ferretti fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Ferretti Using Its Retained Earnings Effectively?

Ferretti's three-year median payout ratio to shareholders is 13% (implying that it retains 87% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

While Ferretti has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 13%. However, Ferretti's ROE is predicted to rise to 8.2% despite there being no anticipated change in its payout ratio.

Summary

On the whole, we feel that Ferretti's performance has been quite good. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.