Tower (NZSE:TWR) has had a great run on the share market with its stock up by a significant 15% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Tower's  ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Tower

How To Calculate Return On Equity?

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 Tower is:

5.6% = NZ$18m ÷ NZ$318m (Based on the trailing twelve months to September 2022).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.06 in profit.

What Is The Relationship Between ROE And 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Tower's Earnings Growth And 5.6% ROE

At first glance, Tower's ROE doesn't look very promising. However, its ROE is similar to the industry average of 6.1%, so we won't completely dismiss the company. Particularly, the exceptional 41% net income growth seen by Tower over the past five years is pretty remarkable. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.



Next, on comparing with the industry net income growth, we found that Tower's growth is quite high when compared to the industry average growth of 8.1% in the same period, which is great to see. past-earnings-growth

Earnings growth is a huge factor in stock valuation. 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. 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 Tower is trading on a high P/E or a low P/E, relative to its industry.

Is Tower Making Efficient Use Of Its Profits?

The really high three-year median payout ratio of 141% for Tower suggests that the company is paying its shareholders more than what it is earning. However, this hasn't hampered its ability to grow as we saw earlier. With that said, it could be worth keeping an eye on the high payout ratio as that's a huge risk.

Besides, Tower has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 77% over the next three years. As a result, the expected drop in Tower's payout ratio explains the anticipated rise in the company's future ROE to 7.3%, over the same period.

Summary

In total, we're a bit ambivalent about Tower's performance. Although the company has shown a pretty impressive growth in earnings, yet the low ROE and the low rate of reinvestment makes us skeptical about the continuity of that growth, especially when or if the business comes to face any threats. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the company's future earnings growth forecasts take a look at this freereport on analyst forecasts for the company to find out more.

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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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