Transpaco Limited's (JSE:TPC) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Transpaco (JSE:TPC) has had a rough week with its share price down 12%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Transpaco'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Transpaco

How Do You 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 Transpaco is:

16% = R153m ÷ R932m (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. So, this means that for every ZAR1 of its shareholder's investments, the company generates a profit of ZAR0.16.

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. 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.

Transpaco's Earnings Growth And 16% ROE

On the face of it, Transpaco's ROE is not much to talk about. Next, when compared to the average industry ROE of 29%, the company's ROE leaves us feeling even less enthusiastic. Transpaco was still able to see a decent net income growth of 19% over the past five years. We reckon that there could 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 Transpaco'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 24% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Transpaco is trading on a high P/E or a low P/E, relative to its industry.

Is Transpaco Making Efficient Use Of Its Profits?

Transpaco has a three-year median payout ratio of 45%, which implies that it retains the remaining 55% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Transpaco 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.

Summary

Overall, we feel that Transpaco certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for Transpaco visit our risks dashboard for free.

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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.