Yahoo Finance Tree Island Steel Ltd.'s (TSE:TSL) Has Had A Decent Run On The Stock market: Are Fundamentals In The Driver's Seat?
Most readers would already know that Tree Island Steel's (TSE:TSL) stock increased by 1.8% 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 investigate if the company's decent financials had a hand to play in the recent price move. In this article, we decided to focus on Tree Island Steel's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Tree Island Steel
How Do You Calculate Return On Equity?
Return on equity 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 Tree Island Steel is:
27% = CA$18m ÷ CA$65m (Based on the trailing twelve months to June 2021).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.27 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Tree Island Steel's Earnings Growth And 27% ROE
First thing first, we like that Tree Island Steel has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 14% which is quite remarkable. Needless to say, we are quite surprised to see that Tree Island Steel's net income shrunk at a rate of 30% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
That being said, we compared Tree Island Steel's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 32% in the same period.
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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Tree Island Steel's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Tree Island Steel Using Its Retained Earnings Effectively?
When we piece together Tree Island Steel's low three-year median payout ratio of 16% (where it is retaining 84% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.
In addition, Tree Island Steel has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.
Conclusion
Overall, we feel that Tree Island Steel certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 4 risks we have identified for Tree Island Steel by visiting our risks dashboard for free on our platform here.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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