Most readers would already be aware that FLEX LNG's (NYSE:FLNG) stock increased significantly by 22% over the past month. 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 FLEX LNG'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for FLEX LNG

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 FLEX LNG is:

11% = US$92m ÷ US$802m (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.11.

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. 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.

FLEX LNG's Earnings Growth And 11% ROE

To begin with, FLEX LNG seems to have a respectable ROE. Yet, the fact that the company's ROE is lower than the industry average of 15% does temper our expectations. Still, we can see that FLEX LNG has seen a remarkable net income growth of 30% over the past five years. Therefore, there could be other causes behind this growth. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the high earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that FLEX LNG's reported growth was lower than the industry growth of 40% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if FLEX LNG is trading on a high P/E or a low P/E, relative to its industry.

Is FLEX LNG Using Its Retained Earnings Effectively?

FLEX LNG has very a high three-year median payout ratio of 108% suggesting that the company's shareholders are getting paid from more than just the company's earnings. Despite this, the company's earnings grew significantly as we saw above. With that said, it could be worth keeping an eye on the high payout ratio as that's a huge risk. Our risks dashboard should have the 3 risks we have identified for FLEX LNG.

Additionally, FLEX LNG has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 147% over the next three years. However, FLEX LNG's future ROE is expected to rise to 18% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

Overall, we have mixed feelings about FLEX LNG. Although the company has grown its earnings moderately as a result of its respectable ROE, yet, the business is retaining hardly any of its profits. This might have negative implications on the company's future growth prospects. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.

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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.