TOTVS S.A.'s (BVMF:TOTS3) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

It is hard to get excited after looking at TOTVS' (BVMF:TOTS3) recent performance, when its stock has declined 7.1% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on TOTVS' 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.

Check out our latest analysis for TOTVS

How Is ROE Calculated?

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 TOTVS is:

11% = R$562m ÷ R$5.1b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. That means that for every R$1 worth of shareholders' equity, the company generated R$0.11 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of TOTVS' Earnings Growth And 11% ROE

It is quite clear that TOTVS' ROE is rather low. An industry comparison shows that the company's ROE is not much different from the industry average of 10% either. Moreover, we are quite pleased to see that TOTVS' net income grew significantly at a rate of 21% over the last five years. Given the low ROE, it is likely that there could be some other reasons behind this growth as well. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that TOTVS' growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.

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. Is TOTVS fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is TOTVS Making Efficient Use Of Its Profits?

TOTVS has a three-year median payout ratio of 41% (where it is retaining 59% of its income) which is not too low or not too high. So it seems that TOTVS is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, TOTVS has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 44% of its profits over the next three years. Still, forecasts suggest that TOTVS' future ROE will rise to 17% even though the the company's payout ratio is not expected to change by much.

Summary

In total, it does look like TOTVS has some positive aspects to its business. 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. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.