Tamawood (ASX:TWD) has had a rough three months with its share price down 23%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study Tamawood'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.
How To Calculate Return On Equity?
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 Tamawood is:
29% = AU$5.7m ÷ AU$20m (Based on the trailing twelve months to December 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.29 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. 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.
Tamawood's Earnings Growth And 29% ROE
Firstly, we acknowledge that Tamawood has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. Needless to say, we are quite surprised to see that Tamawood's net income shrunk at a rate of 14% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
However, when we compared Tamawood's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 13% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Tamawood's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Tamawood Making Efficient Use Of Its Profits?
With a three-year median payout ratio as high as 113%,Tamawood's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Paying a dividend beyond their means is usually not viable over the long term. You can see the 5 risks we have identified for Tamawood by visiting our risks dashboard for free on our platform here.
Moreover, Tamawood has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
On the whole, we feel that the performance shown by Tamawood can be open to many interpretations. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Tamawood's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.
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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.
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