Most readers would already be aware that Tennant's (NYSE:TNC) stock increased significantly by 16% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Tennant's ROE in this article.
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.
How Do You Calculate Return On Equity?
ROE 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 Tennant is:
11% = US$42m ÷ US$395m (Based on the trailing twelve months to September 2020).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.11 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Tennant's Earnings Growth And 11% ROE
To begin with, Tennant seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 11%. This probably goes some way in explaining Tennant's moderate 6.5% growth over the past five years amongst other factors.
As a next step, we compared Tennant'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 9.4% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is TNC worth today? The intrinsic value infographic in our free research report helps visualize whether TNC is currently mispriced by the market.
Is Tennant Efficiently Re-investing Its Profits?
With a three-year median payout ratio of 42% (implying that the company retains 58% of its profits), it seems that Tennant is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Moreover, Tennant 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 26% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
In total, we are pretty happy with Tennant'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 respectable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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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