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It is hard to get excited after looking at Tennant's (NYSE:TNC) recent performance, when its stock has declined 11% over the past month. 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 Tennant's ROE in this article.
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.
See our latest analysis for Tennant
How Is ROE Calculated?
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 Tennant is:
18% = US$95m ÷ US$522m (Based on the trailing twelve months to June 2023).
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 $0.18 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
A Side By Side comparison of Tennant's Earnings Growth And 18% ROE
At first glance, Tennant seems to have a decent ROE. Especially when compared to the industry average of 14% the company's ROE looks pretty impressive. This certainly adds some context to Tennant's exceptional 21% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Tennant's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.2%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Tennant is trading on a high P/E or a low P/E, relative to its industry.