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Are Strong Financial Prospects The Force That Is Driving The Momentum In Tractor Supply Company's NASDAQ:TSCO) Stock?

Most readers would already be aware that Tractor Supply's (NASDAQ:TSCO) stock increased significantly by 67% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Tractor Supply's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Tractor Supply

How Is ROE Calculated?

The formula for ROE is:

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Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Tractor Supply is:

42% = US$569m ÷ US$1.4b (Based on the trailing twelve months to March 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.42.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Tractor Supply's Earnings Growth And 42% ROE

Firstly, we acknowledge that Tractor Supply has a significantly high ROE. Secondly, even when compared to the industry average of 15% the company's ROE is quite impressive. Probably as a result of this, Tractor Supply was able to see a decent net income growth of 8.0% over the last five years.

Next, on comparing Tractor Supply's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 6.8% in the same period.

NasdaqGS:TSCO Past Earnings Growth July 3rd 2020
NasdaqGS:TSCO Past Earnings Growth July 3rd 2020

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Tractor Supply's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Tractor Supply Efficiently Re-investing Its Profits?

Tractor Supply has a three-year median payout ratio of 29%, which implies that it retains the remaining 71% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Tractor Supply is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 28%. As a result, Tractor Supply's ROE is not expected to change by much either, which we inferred from the analyst estimate of 39% for future ROE.

Summary

On the whole, we feel that Tractor Supply's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

This article by Simply Wall St is general in nature. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.