Are Strong Financial Prospects The Force That Is Driving The Momentum In Focusrite plc's LON:TUNE) Stock?

Focusrite (LON:TUNE) has had a great run on the share market with its stock up by a significant 11% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Focusrite's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Focusrite

How Do You Calculate Return On Equity?

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 Focusrite is:

24% = UK£22m ÷ UK£94m (Based on the trailing twelve months to February 2022).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.24 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Focusrite's Earnings Growth And 24% ROE

First thing first, we like that Focusrite has an impressive ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. Under the circumstances, Focusrite's considerable five year net income growth of 24% was to be expected.

Next, on comparing with the industry net income growth, we found that the growth figure reported by Focusrite compares quite favourably to the industry average, which shows a decline of 5.7% in the same period.

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 TUNE? You can find out in our latest intrinsic value infographic research report.

Is Focusrite Using Its Retained Earnings Effectively?

Focusrite's three-year median payout ratio to shareholders is 18%, which is quite low. This implies that the company is retaining 82% of its profits. So it looks like Focusrite is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, Focusrite is determined to keep sharing its profits with shareholders which we infer from its long history of seven years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 12% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

Overall, we are quite pleased with Focusrite's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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.

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