Topps Tiles Plc's (LON:TPT) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Topps Tiles' (LON:TPT) stock is up by a considerable 16% over the past month. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Topps Tiles' ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Topps Tiles

How Do You Calculate Return On Equity?

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 Topps Tiles is:

6.2% = UK£1.2m ÷ UK£20m (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.06 in profit.

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. 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 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 Topps Tiles' Earnings Growth And 6.2% ROE

When you first look at it, Topps Tiles' ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.7%. However, Topps Tiles has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 10% over the last few years.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for TPT? You can find out in our latest intrinsic value infographic research report.

Is Topps Tiles Using Its Retained Earnings Effectively?

Topps Tiles has a very high three-year median payout ratio of 102% over the last last three years, which suggests that the company is dipping into more than just its earnings to pay its dividend. This does go some way in explaining the negligible earnings growth seen by Topps Tiles. Paying a dividend beyond their means is usually not viable over the long term. This is indicative of risk. You can see the 2 risks we have identified for Topps Tiles by visiting our risks dashboard for free on our platform here.

Additionally, Topps Tiles has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 70% over the next three years.

Summary

Overall, we would be extremely cautious before making any decision on Topps Tiles. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.