Is Weakness In TClarke plc (LON:CTO) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?
TClarke (LON:CTO) has had a rough week with its share price down 11%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study TClarke'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for TClarke
How To Calculate Return On Equity?
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 TClarke is:
22% = UK£8.4m ÷ UK£39m (Based on the trailing twelve months to December 2022).
The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.22.
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.
TClarke's Earnings Growth And 22% ROE
To begin with, TClarke has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 9.1% which is quite remarkable. However, for some reason, the higher returns aren't reflected in TClarke's meagre five year net income growth average of 2.2%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
We then performed a comparison between TClarke's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 2.2% in the same period.
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. Doing so will help them establish if the stock's future looks promising or ominous. Is TClarke fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is TClarke Efficiently Re-investing Its Profits?
Despite having a moderate three-year median payout ratio of 34% (implying that the company retains the remaining 66% of its income), TClarke's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
In addition, TClarke has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
Summary
In total, we are pretty happy with TClarke'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 respectable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard will have the 1 risk we have identified for TClarke.
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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