Declining Stock and Solid Fundamentals: Is The Market Wrong About National Tyre & Wheel Limited (ASX:NTD)?

With its stock down 20% over the past three months, it is easy to disregard National Tyre & Wheel (ASX:NTD). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study National Tyre & Wheel'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for National Tyre & Wheel

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for National Tyre & Wheel is:

16% = AU$16m ÷ AU$101m (Based on the trailing twelve months to December 2021).

The 'return' is the yearly profit. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.16 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. 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.

National Tyre & Wheel's Earnings Growth And 16% ROE

To begin with, National Tyre & Wheel seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 8.7%. This certainly adds some context to National Tyre & Wheel's exceptional 35% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared National Tyre & Wheel's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 18% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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 National Tyre & Wheel is trading on a high P/E or a low P/E, relative to its industry.

Is National Tyre & Wheel Using Its Retained Earnings Effectively?

National Tyre & Wheel's three-year median payout ratio is a pretty moderate 46%, meaning the company retains 54% of its income. So it seems that National Tyre & Wheel is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, National Tyre & Wheel has been paying dividends over a period of four years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 53% of its profits over the next three years. As a result, National Tyre & Wheel's ROE is not expected to change by much either, which we inferred from the analyst estimate of 14% for future ROE.

Summary

Overall, we are quite pleased with National Tyre & Wheel'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 substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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