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Touchstar (LON:TST) has had a great run on the share market with its stock up by a significant 15% over the last week. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Touchstar's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Touchstar
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Touchstar is:
17% = UK£599k ÷ UK£3.6m (Based on the trailing twelve months to June 2024).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.17 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
A Side By Side comparison of Touchstar's Earnings Growth And 17% ROE
To start with, Touchstar's ROE looks acceptable. Even when compared to the industry average of 15% the company's ROE looks quite decent. This probably goes some way in explaining Touchstar's significant 54% net income growth over the past five years amongst other factors. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared Touchstar'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 18%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Touchstar's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.