Most readers would already be aware that Cognizant Technology Solutions’ (NASDAQ:CTSH) stock increased significantly by 12% over the past month. Given that stock prices are usually aligned with a company’s financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Cognizant Technology Solutions’ ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
Check out our latest analysis for Cognizant Technology Solutions
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Cognizant Technology Solutions is:
15% = US$1.7b ÷ US$11b (Based on the trailing twelve months to June 2021).
The ‘return’ is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.15 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. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don’t have the same features.
Cognizant Technology Solutions’ Earnings Growth And 15% ROE
To begin with, Cognizant Technology Solutions seems to have a respectable ROE. Even when compared to the industry average of 19% the company’s ROE looks quite decent. Despite this, Cognizant Technology Solutions’ five year net income growth was quite flat over the past five years. Based on this, we feel that there might be other reasons which haven’t been discussed so far in this article that could be hampering the company’s growth. These include low earnings retention or poor allocation of capital.
We then compared Cognizant Technology Solutions’ net income growth with the industry and found that the company’s growth figure is lower than the average industry growth rate of 14% in the same period, which is a bit concerning.
NasdaqGS:CTSH Past Earnings Growth August 14th 2021
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is CTSH fairly valued? This infographic on the company’s intrinsic value has everything you need to know.
Is Cognizant Technology Solutions Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 28% (meaning the company retains72% of profits) in the last three-year period, Cognizant Technology Solutions’ earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company’s business may be deteriorating.
Moreover, Cognizant Technology Solutions has been paying dividends for four years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. 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 24%. Accordingly, forecasts suggest that Cognizant Technology Solutions’ future ROE will be 18% which is again, similar to the current ROE.
On the whole, we do feel that Cognizant Technology Solutions has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn’t the case here. This suggests that there might be some external threat to the business, that’s hampering its growth. With that said, the latest industry analyst forecasts reveal that the company’s earnings are expected to accelerate. 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.
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