InnoTec TSS' (FRA:TSS) stock is up by a considerable 18% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on InnoTec TSS' ROE.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for InnoTec TSS
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 InnoTec TSS is:
12% = €11m ÷ €89m (Based on the trailing twelve months to December 2022).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.12 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
InnoTec TSS' Earnings Growth And 12% ROE
At first glance, InnoTec TSS seems to have a decent ROE. Even when compared to the industry average of 15% the company's ROE looks quite decent. For this reason, InnoTec TSS' five year net income decline of 7.8% raises the question as to why the decent ROE didn't translate into growth. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.
So, as a next step, we compared InnoTec TSS' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 15% in the same period.
Earnings growth is a huge factor in stock valuation. 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 InnoTec TSS is trading on a high P/E or a low P/E, relative to its industry.