Fabrinet (NYSE:FN) has had a rough three months with its share price down 20%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Fabrinet'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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 Fabrinet is:

16% = US$254m ÷ US$1.6b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.16 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. 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 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 Fabrinet's Earnings Growth And 16% ROE

At first glance, Fabrinet seems to have a decent ROE. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. This probably laid the ground for Fabrinet's significant 20% net income growth seen over the past five years. We reckon that there could also be other factors at play here. 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 Fabrinet's growth is quite high when compared to the industry average growth of 16% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is FN fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Fabrinet Making Efficient Use Of Its Profits?

Given that Fabrinet doesn't pay any regular dividends to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

Overall, we are quite pleased with Fabrinet'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 substantial growth in its earnings. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.