Most readers would already be aware that Texas Roadhouse's (NASDAQ:TXRH) stock increased significantly by 42% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Texas Roadhouse is:
16% = US$146m ÷ US$911m (Based on the trailing twelve months to March 2020).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.16.
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. 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 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.
Texas Roadhouse's Earnings Growth And 16% ROE
To start with, Texas Roadhouse's ROE looks acceptable. Even when compared to the industry average of 14% the company's ROE looks quite decent. This certainly adds some context to Texas Roadhouse's moderate 12% net income growth seen over the past five years.
We then performed a comparison between Texas Roadhouse's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 12% 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. If you're wondering about Texas Roadhouse's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Texas Roadhouse Making Efficient Use Of Its Profits?
Texas Roadhouse has a three-year median payout ratio of 47%, which implies that it retains the remaining 53% 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.
Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 26% over the next three years. Regardless, the future ROE for Texas Roadhouse is predicted to decline to 11% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.
Overall, we are quite pleased with Texas Roadhouse's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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. 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. Thank you for reading.