It’s hard to get excited after watching the recent performance of Formula Systems (1985) (TLV:FORTY), as its stock is down 6.5% over the past week. However, a closer look at his healthy finances might make you think again. Since fundamentals generally determine long-term market outcomes, the company is worth looking into. Specifically, we decided to study the ROE of Formula Systems (1985) in this article.

ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In other words, it reveals the company’s success in turning shareholders’ investments into profits.

See our latest analysis for Formula Systems (1985)

How to calculate return on equity?

ROE can be calculated using the formula:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the above formula, the ROE for Formula Systems (1985) is:

13% = $152 million ÷ $1.2 billion (based on trailing 12 months to March 2022).

The “yield” is the amount earned after tax over the last twelve months. One way to conceptualize this is that for every ₪1 of share capital it has, the company has made a profit of 0.13₪.

What does ROE have to do with earnings growth?

So far, we have learned that ROE measures how efficiently a company generates its profits. Depending on how much of its profits the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.

Profit growth and ROE of 13% from Formula Systems (1985)

At first glance, Formula Systems (1985) seems to have a decent ROE. Regardless, the company’s ROE is still well below the industry average of 25%. Yet, we can see that Formula Systems (1985) has experienced remarkable net income growth of 26% over the past five years. Therefore, there could be other causes behind this growth. For example, the business has a low payout ratio or is efficiently managed. However, it’s worth remembering that the company has a decent ROE to start with, just that it’s below the industry average. So that certainly provides some context to the strong earnings growth the company is seeing.

In a next step, we compared the growth of net income of Formula Systems (1985) with the industry, and fortunately, we found that the growth observed by the company is higher than the industry average growth of 12 %.

The basis for attaching value to a company is, to a large extent, linked to the growth of its profits. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. By doing so, they will get an idea if the stock is headed for clear blue waters or if swampy waters are waiting. If you’re wondering about Formula Systems’ (1985) valuation, check out this indicator of its price-earnings ratio, relative to its industry.

Does Formula Systems (1985) effectively reinvest its profits?

Formula Systems (1985) has a three-year median payout ratio of 38% (where it retains 62% of its revenue), which is neither too low nor too high. So it looks like Formula Systems (1985) is effectively reinvesting to see impressive earnings growth (discussed above) and paying a well-covered dividend.

Additionally, Formula Systems (1985) paid dividends over a nine-year period. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

Overall, we feel Formula Systems (1985) performed quite well. In particular, we appreciate the fact that the company reinvests heavily in its business at a moderate rate of return. Unsurprisingly, this led to impressive earnings growth.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.