Tractor Supply (NASDAQ:TSCO) has had a rough week with its share price down 5.6%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Tractor Supply'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Is ROE Calculated?

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 Tractor Supply is:

49% = US$1.1b ÷ US$2.3b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.49 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.

Tractor Supply's Earnings Growth And 49% ROE

Firstly, we acknowledge that Tractor Supply has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 19% which is quite remarkable. This likely paved the way for the modest 13% net income growth seen by Tractor Supply over the past five years.

We then compared Tractor Supply's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 17% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. 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. What is TSCO worth today? The intrinsic value infographic in our free research report helps visualize whether TSCO is currently mispriced by the market.

Is Tractor Supply Using Its Retained Earnings Effectively?

Tractor Supply has a healthy combination of a moderate three-year median payout ratio of 39% (or a retention ratio of 61%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 43%. As a result, Tractor Supply's ROE is not expected to change by much either, which we inferred from the analyst estimate of 48% for future ROE.

Conclusion

Overall, we are quite pleased with Tractor Supply's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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 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.