Tesco PLC's (LON:TSCO) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?
Tesco (LON:TSCO) has had a rough month with its share price down 2.2%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Tesco's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You Calculate Return On Equity?
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 Tesco is:
14% = UK£1.5b ÷ UK£11b (Based on the trailing twelve months to August 2025).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.14 in profit.
Check out our latest analysis for Tesco
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. 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.
Tesco's Earnings Growth And 14% ROE
To start with, Tesco's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 9.8%. This certainly adds some context to Tesco's decent 17% net income growth seen over the past five years.
As a next step, we compared Tesco's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 18% in the same period.
Earnings growth is a huge factor in stock valuation. 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. 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 Tesco Making Efficient Use Of Its Profits?
While Tesco has a three-year median payout ratio of 60% (which means it retains 40% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.
Moreover, Tesco is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 51% of its profits over the next three years. Still, forecasts suggest that Tesco's future ROE will rise to 17% even though the the company's payout ratio is not expected to change by much.
Conclusion
In total, we are pretty happy with Tesco's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. 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.
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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.