Tax-Net S.A.'s (WSE:TXN) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Tax-Net (WSE:TXN) has had a great run on the share market with its stock up by a significant 12% over the last week. 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. Specifically, we decided to study Tax-Net's ROE in this article.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

We've discovered 6 warning signs about Tax-Net. View them for free.

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 Tax-Net is:

4.2% = zł120k ÷ zł2.9m (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every PLN1 worth of equity, the company was able to earn PLN0.04 in profit.

Check out our latest analysis for Tax-Net

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. 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.

Tax-Net's Earnings Growth And 4.2% ROE

As you can see, Tax-Net's ROE looks pretty weak. Even compared to the average industry ROE of 14%, the company's ROE is quite dismal. Although, we can see that Tax-Net saw a modest net income growth of 12% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Tax-Net's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 20% in the same period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Efficiently Re-investing Its Profits?

Tax-Net's high three-year median payout ratio of 192% suggests that the company is paying out more to its shareholders than what it is making. Still the company's earnings have grown respectably. Although, the high payout ratio is certainly something we would keep an eye on if the company is not able to keep up its growth, or if business deteriorates. Our risks dashboard should have the 6 risks we have identified for Tax-Net.

Moreover, Tax-Net 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.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Tax-Net. Although the company has shown a fair bit of growth in earnings, yet the low ROE and the low rate of reinvestment makes us skeptical about the continuity of that growth, especially when or if the business comes to face any threats. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on Tax-Net and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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.