Declining Stock and Solid Fundamentals: Is The Market Wrong About Tax-Net S.A. (WSE:TXN)?

With its stock down 17% over the past month, it is easy to disregard Tax-Net (WSE:TXN). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Tax-Net's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Tax-Net

How Is ROE Calculated?

Return on equity 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 Tax-Net is:

13% = zł541k ÷ zł4.2m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every PLN1 worth of shareholders' equity, the company generated PLN0.13 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Tax-Net's Earnings Growth And 13% ROE

To start with, Tax-Net's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 13%. This probably goes some way in explaining Tax-Net's significant 25% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Tax-Net's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 25% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Tax-Net's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Tax-Net Making Efficient Use Of Its Profits?

Given that Tax-Net doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Conclusion

Overall, we are quite pleased with Tax-Net's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable 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 would have the 3 risks we have identified for Tax-Net.

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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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