Will Weakness in Tax-Net S.A.'s (WSE:TXN) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 24% over the past week, it is easy to disregard Tax-Net (WSE:TXN). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Tax-Net's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Tax-Net

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Tax-Net is:

18% = zł797k ÷ zł4.5m (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each PLN1 of shareholders' capital it has, the company made PLN0.18 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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 Tax-Net's Earnings Growth And 18% ROE

To start with, Tax-Net's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 18%. Consequently, this likely laid the ground for the impressive net income growth of 32% seen over the past five years by Tax-Net. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Tax-Net's growth is quite high when compared to the industry average growth of 20% in the same period, which is great to see.

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). Doing so will help them establish if the stock's future looks promising or ominous. 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 Using Its Retained Earnings Effectively?

Tax-Net's significant three-year median payout ratio of 65% (where it is retaining only 35% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Besides, Tax-Net has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

Overall, we are quite pleased with Tax-Net's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. Up till now, we've only made a short study of the company's growth data. To gain further insights into Tax-Net's past profit growth, check out this visualization 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.