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Transcat's (NASDAQ:TRNS) stock up by 8.8% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Transcat's ROE today.
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 Transcat
How Do You Calculate Return On Equity?
ROE 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 Transcat is:
12% = US$11m ÷ US$90m (Based on the trailing twelve months to June 2022).
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 $0.12 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Transcat's Earnings Growth And 12% ROE
At first glance, Transcat seems to have a decent ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 22%. Although, we can see that Transcat saw a modest net income growth of 16% over the past five years. So, there might be other aspects that are positively influencing 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. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the fairly high earnings growth seen by the company.
Next, on comparing Transcat's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 16% in the same period.
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. Is Transcat fairly valued compared to other companies? These 3 valuation measures might help you decide.