Euro-Tax.pl (WSE:ETX) has had a rough three months with its share price down 22%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Euro-Tax.pl's 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.
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 Euro-Tax.pl is:
19% = zł313k ÷ zł1.7m (Based on the trailing twelve months to December 2020).
The 'return' is the yearly profit. One way to conceptualize this is that for each PLN1 of shareholders' capital it has, the company made PLN0.19 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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 Euro-Tax.pl's Earnings Growth And 19% ROE
To start with, Euro-Tax.pl's ROE looks acceptable. On comparing with the average industry ROE of 6.2% the company's ROE looks pretty remarkable. For this reason, Euro-Tax.pl's five year net income decline of 28% raises the question as to why the high ROE didn't translate into earnings growth. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
So, as a next step, we compared Euro-Tax.pl's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 12% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Euro-Tax.pl is trading on a high P/E or a low P/E, relative to its industry.
Is Euro-Tax.pl Efficiently Re-investing Its Profits?
With a three-year median payout ratio as high as 124%,Euro-Tax.pl's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Paying a dividend higher than reported profits is not a sustainable move. To know the 5 risks we have identified for Euro-Tax.pl visit our risks dashboard for free.
Moreover, Euro-Tax.pl has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
Overall, we have mixed feelings about Euro-Tax.pl. In spite of the high ROE, the company has failed to see growth in its earnings due to it paying out most of its profits as dividend, with almost nothing left to invest into its own business. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Euro-Tax.pl's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.
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