Yahoo Finance TT Electronics plc's (LON:TTG) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?
TT Electronics (LON:TTG) has had a great run on the share market with its stock up by a significant 28% over the last month. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to TT Electronics' ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for TT Electronics
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 TT Electronics is:
3.1% = UK£11m ÷ UK£360m (Based on the trailing twelve months to June 2022).
The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.03 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. 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. 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.
TT Electronics' Earnings Growth And 3.1% ROE
On the face of it, TT Electronics' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 9.0% either. Therefore, it might not be wrong to say that the five year net income decline of 15% seen by TT Electronics was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
Next, when we compared with the industry, which has shrunk its earnings at a rate of 6.7% in the same period, we still found TT Electronics' performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is TTG fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is TT Electronics Efficiently Re-investing Its Profits?
TT Electronics has a high three-year median payout ratio of 88% (that is, it is retaining 12% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. Our risks dashboard should have the 2 risks we have identified for TT Electronics.
Additionally, TT Electronics has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 36% over the next three years. As a result, the expected drop in TT Electronics' payout ratio explains the anticipated rise in the company's future ROE to 10%, over the same period.
Conclusion
On the whole, TT Electronics' performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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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