Travis Perkins (LON:TPK) has had a great run on the share market with its stock up by a significant 15% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Travis Perkins' ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Travis Perkins is:
12% = UK£247m ÷ UK£2.1b (Based on the trailing twelve months to June 2022).
The 'return' refers to a company's earnings over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.12 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. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Travis Perkins' Earnings Growth And 12% ROE
At first glance, Travis Perkins seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 14%. Consequently, this likely laid the ground for the impressive net income growth of 30% seen over the past five years by Travis Perkins. We reckon that there could also 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 Travis Perkins' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 9.9%.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Travis Perkins is trading on a high P/E or a low P/E, relative to its industry.
Is Travis Perkins Making Efficient Use Of Its Profits?
Travis Perkins' three-year median payout ratio is a pretty moderate 31%, meaning the company retains 69% of its income. So it seems that Travis Perkins is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.
Moreover, Travis Perkins 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 38% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 7.9%) over the same period.
On the whole, we feel that Travis Perkins' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.
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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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