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With its stock down 30% over the past week, it is easy to disregard Tasty (LON:TAST). 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 Tasty's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Tasty
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 Tasty is:
74% = UK£1.3m ÷ UK£1.7m (Based on the trailing twelve months to June 2022).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.74 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. 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.
A Side By Side comparison of Tasty's Earnings Growth And 74% ROE
First thing first, we like that Tasty has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 14% which is quite remarkable. So, the substantial 25% net income growth seen by Tasty over the past five years isn't overly surprising.
Given that the industry shrunk its earnings at a rate of 13% in the same period, the net income growth of the company is quite impressive.
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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Tasty is trading on a high P/E or a low P/E, relative to its industry.
Is Tasty Using Its Retained Earnings Effectively?
Tasty doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.