Is National Tyre & Wheel Limited's (ASX:NTD) Recent Stock Performance Influenced By Its Fundamentals In Any Way?

National Tyre & Wheel (ASX:NTD) has had a great run on the share market with its stock up by a significant 24% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to National Tyre & Wheel's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for National Tyre & Wheel

How Do You Calculate Return On Equity?

Return on equity 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 National Tyre & Wheel is:

6.1% = AU$4.2m ÷ AU$69m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.06 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of National Tyre & Wheel's Earnings Growth And 6.1% ROE

At first glance, National Tyre & Wheel's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 6.6%, we may spare it some thought. Even so, National Tyre & Wheel has shown a fairly decent growth in its net income which grew at a rate of 11%. Considering the moderately low ROE, it is quite possible that there might be some 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.

As a next step, we compared National Tyre & Wheel's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 14% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 National Tyre & Wheel is trading on a high P/E or a low P/E, relative to its industry.

Is National Tyre & Wheel Efficiently Re-investing Its Profits?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.

Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 50% of its profits over the next three years. However, National Tyre & Wheel's ROE is predicted to rise to 15% despite there being no anticipated change in its payout ratio.

Summary

Overall, we feel that National Tyre & Wheel certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 3 risks we have identified for National Tyre & Wheel by visiting our risks dashboard for free on our platform here.

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This article by Simply Wall St is general in nature. 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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