Transcontinental's (TSE:TCL.A) stock is up by a considerable 25% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Transcontinental's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You Calculate Return On Equity?
ROE 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 Transcontinental is:
7.6% = CA$132m ÷ CA$1.7b (Based on the trailing twelve months to October 2020).
The 'return' refers to a company's earnings over the last year. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.08.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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 Transcontinental's Earnings Growth And 7.6% ROE
On the face of it, Transcontinental's ROE is not much to talk about. However, its ROE is similar to the industry average of 9.0%, so we won't completely dismiss the company. Having said that, Transcontinental's five year net income decline rate was 6.7%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.
That being said, we compared Transcontinental'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 21% in the same period.
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. This then helps them determine if the stock is placed for a bright or bleak future. Is Transcontinental fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Transcontinental Efficiently Re-investing Its Profits?
In spite of a normal three-year median payout ratio of 40% (that is, a retention ratio of 60%), the fact that Transcontinental's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
In addition, Transcontinental 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 over the next three years is expected to be approximately 45%. However, Transcontinental's ROE is predicted to rise to 10.0% despite there being no anticipated change in its payout ratio.
In total, we're a bit ambivalent about Transcontinental's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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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