Texas Roadhouse's (NASDAQ:TXRH) stock up by 1.6% over the past month. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Texas Roadhouse's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Texas Roadhouse is:

30% = US$380m ÷ US$1.3b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.30 in profit.

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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Texas Roadhouse's Earnings Growth And 30% ROE

Firstly, we acknowledge that Texas Roadhouse has a significantly high ROE. Secondly, even when compared to the industry average of 17% the company's ROE is quite impressive. So, the substantial 25% net income growth seen by Texas Roadhouse over the past five years isn't overly surprising.

As a next step, we compared Texas Roadhouse'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 31% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Texas Roadhouse fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Texas Roadhouse Using Its Retained Earnings Effectively?

Texas Roadhouse's three-year median payout ratio is a pretty moderate 46%, meaning the company retains 54% of its income. So it seems that Texas Roadhouse is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Additionally, Texas Roadhouse has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. 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 37%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 32%.

Conclusion

On the whole, we feel that Texas Roadhouse's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.