freenet AG's (ETR:FNTN) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

editorial-team@simplywallst.com (Simply Wall St)

Sun, Dec 8, 2024, 10:13 PM 4 min read

freenet (ETR:FNTN) has had a great run on the share market with its stock up by a significant 11% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on freenet's ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for freenet

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 freenet is:

19% = €274m ÷ €1.4b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. That means that for every €1 worth of shareholders' equity, the company generated €0.19 in profit.

What Has ROE Got To Do With 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of freenet's Earnings Growth And 19% ROE

To begin with, freenet seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 5.3%. As you might expect, the 5.2% net income decline reported by freenet is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

That being said, we compared freenet's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 1.6% in the same 5-year period.

past-earnings-growth — XTRA:FNTN Past Earnings Growth December 9th 2024

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 freenet fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is freenet Efficiently Re-investing Its Profits?

freenet's very high three-year median payout ratio of 126% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Its usually very hard to sustain dividend payments that are higher than reported profits.

In addition, freenet has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 75% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Conclusion

On the whole, we feel that the performance shown by freenet can be open to many interpretations. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.