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With its stock down 35% over the past three months, it is easy to disregard Treatt (LON:TET). 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. In this article, we decided to focus on Treatt's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Treatt
How To Calculate Return On Equity?
Return on equity 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 Treatt is:
14% = UK£16m ÷ UK£115m (Based on the trailing twelve months to March 2022).
The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.14 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Treatt's Earnings Growth And 14% ROE
To begin with, Treatt seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 14%. This probably goes some way in explaining Treatt's moderate 14% growth over the past five years amongst other factors.
We then compared Treatt'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 3.4% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Treatt fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Treatt Using Its Retained Earnings Effectively?
Treatt has a healthy combination of a moderate three-year median payout ratio of 32% (or a retention ratio of 68%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.