With its stock down 4.5% over the past three months, it’s easy to ignore Tractor Supply (NASDAQ:TSCO). But if you look closely, you’ll see that its strong financials could mean the stock could potentially increase in value over the long term, considering that markets typically reward companies with good financial health. In this article, we’ve focused on Tractor Supply’s return on equity.

ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investments it receives from its shareholders. Simply put, it is used to evaluate the profitability of a company relative to its equity.

Check out our latest analysis for Tractor Supply

How do you calculate return on equity?

ROE can be calculated using the following formula:

Return on equity = Net profit (from continuing operations) ÷ Equity

Based on the above formula, the ROE for Tractor Supply is:

49% = $1.1 billion ÷ $2.3 billion (based on the trailing twelve months ending June 2024).

The “return” refers to a company’s earnings over the last year. You can think of it as the company making $0.49 in profit for every dollar of shareholders’ capital.

What does return on equity (ROE) have to do with earnings growth?

We have already established that return on equity (ROE) serves as an efficient measure of a company’s future earnings. Now we need to evaluate how much profit the company reinvests or “retains” for future growth, which gives us an idea of ​​the company’s growth potential. Assuming everything else remains unchanged, companies that have both a higher return on equity and higher earnings retention are usually those that have a higher growth rate compared to companies that do not have the same characteristics.

Tractor Supply’s earnings growth and return on equity of 49%

First of all, Tractor Supply has a pretty high return on equity, which is interesting. Moreover, the company’s return on equity is higher than the industry average of 20%, which is quite remarkable. Probably because of this, Tractor Supply has been able to post a decent net income growth of 15% over the past five years.

We then compared Tractor Supply’s net income growth with that of the industry and concluded that the company’s growth rate is below the average industry growth rate of 21% over the same 5-year period, which is a little worrying.

Earnings growth is an important factor in stock valuation. Next, investors need to determine whether the expected earnings growth, or lack thereof, is already factored into the stock price. This then helps them determine whether the stock is positioned for a good or bad future. Is TSCO fairly valued? This infographic on the company’s intrinsic value has everything you need to know.

Does Tractor Supply use its profits efficiently?

Tractor Supply has a healthy combination of a modest three-year average payout ratio of 38% (or a retention ratio of 62%) and notable earnings growth, as we saw above, meaning the company is using its earnings efficiently.

Additionally, Tractor Supply has been paying dividends for at least ten years, which shows that the company is committed to sharing its profits with its shareholders. Based on the latest analyst estimates, we found that the company’s future payout ratio is expected to remain stable at 42% over the next three years. As a result, Tractor Supply’s return on equity is also not expected to change significantly, which we derived from the analyst estimate of 47% for future return on equity.

Summary

Overall, we are very pleased with Tractor Supply’s performance. In particular, we like that the company reinvests a large portion of its profits at a high rate of return. This has naturally led to the company posting good earnings growth. However, a study of the latest analyst forecasts shows that the company is expected to experience a slowdown in its earnings growth going forward. For more information on the latest analyst forecasts for the company, check out this visualization of analyst forecasts for the company.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.