Texas Roadhouse, Inc.'s (NASDAQ:TXRH) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Texas Roadhouse's (NASDAQ:TXRH) recent performance, when its stock has declined 4.8% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Texas Roadhouse's ROE.

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

View our latest analysis for Texas Roadhouse

How Is ROE Calculated?

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 Texas Roadhouse is:

30% = US$401m ÷ US$1.3b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.30 in profit.

Why Is ROE Important For 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. 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.

Texas Roadhouse's Earnings Growth And 30% ROE

Firstly, we acknowledge that Texas Roadhouse has a significantly high ROE. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. So, the substantial 26% net income growth seen by Texas Roadhouse over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Texas Roadhouse's reported growth was lower than the industry growth of 33% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Texas Roadhouse fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Texas Roadhouse Efficiently Re-investing Its Profits?

Texas Roadhouse has a three-year median payout ratio of 46% (where it is retaining 54% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Texas Roadhouse is reinvesting its earnings efficiently.

Moreover, Texas Roadhouse 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 45%. As a result, Texas Roadhouse's ROE is not expected to change by much either, which we inferred from the analyst estimate of 30% for future ROE.

Conclusion

In total, we are pretty happy with Texas Roadhouse's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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. 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.