Most readers would already be aware that Tandem Group's (LON:TND) stock increased significantly by 8.2% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Tandem Group's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 Tandem Group is:
20% = UK£3.0m ÷ UK£15m (Based on the trailing twelve months to June 2020).
The 'return' is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.20 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Tandem Group's Earnings Growth And 20% ROE
To start with, Tandem Group's ROE looks acceptable. On comparing with the average industry ROE of 16% the company's ROE looks pretty remarkable. This certainly adds some context to Tandem Group's decent 20% net income growth seen over the past five years.
As a next step, we compared Tandem Group's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.2%.
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 Tandem Group fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Tandem Group Making Efficient Use Of Its Profits?
Tandem Group has a low three-year median payout ratio of 12%, meaning that the company retains the remaining 88% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Moreover, Tandem Group is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.
On the whole, we feel that Tandem Group's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard will have the 1 risk we have identified for Tandem Group.
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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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