It is hard to get excited after looking at FirstService's (TSE:FSV) recent performance, when its stock has declined 9.8% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on FirstService's ROE.

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.

We've discovered 2 warning signs about FirstService. View them for free.

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for FirstService is:

11% = US$188m ÷ US$1.6b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.11.

Check out our latest analysis for FirstService

Why Is ROE Important For Earnings Growth?

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

FirstService's Earnings Growth And 11% ROE

To start with, FirstService's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 9.8%. Consequently, this likely laid the ground for the impressive net income growth of 32% seen over the past five years by FirstService. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared FirstService's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 14% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about FirstService's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is FirstService Making Efficient Use Of Its Profits?

FirstService's three-year median payout ratio is a pretty moderate 30%, meaning the company retains 70% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like FirstService is reinvesting its earnings efficiently.

Besides, FirstService has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 19% over the next three years. The fact that the company's ROE is expected to rise to 20% over the same period is explained by the drop in the payout ratio.

Conclusion

Overall, we are quite pleased with FirstService'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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.