Cognizant Technology Solutions (NASDAQ:CTSH) has had a rough week with its share price down 3.7%. 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. Specifically, we decided to study Cognizant Technology Solutions’ ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. Put another way, it reveals the company’s success at turning shareholder investments into profits.
Check out our latest analysis for Cognizant Technology Solutions
How Is ROE Calculated?
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:
16% = US$2.2b ÷ US$14b (Based on the trailing twelve months to June 2024).
The ‘return’ is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.16 in profit.
What Has ROE Got To Do With 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.
A Side By Side comparison of Cognizant Technology Solutions’ Earnings Growth And 16% ROE
To start with, Cognizant Technology Solutions’ ROE looks acceptable. Further, the company’s ROE is similar to the industry average of 14%. Consequently, this likely laid the ground for the decent growth of 5.5% seen over the past five years by Cognizant Technology Solutions.
We then performed a comparison between Cognizant Technology Solutions’ net income growth with the industry, which revealed that the company’s growth is similar to the average industry growth of 5.4% in the same 5-year period.
Earnings growth is a huge factor in stock valuation. 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 Efficiently Re-investing Its Profits?
With a three-year median payout ratio of 26% (implying that the company retains 74% of its profits), it seems that Cognizant Technology Solutions is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that’s well covered.
Besides, Cognizant Technology Solutions has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts’ consensus data, we found that the company is expected to keep paying out approximately 26% of its profits over the next three years. As a result, Cognizant Technology Solutions’ ROE is not expected to change by much either, which we inferred from the analyst estimate of 16% for future ROE.
Summary
Overall, we are quite pleased with Cognizant Technology Solutions’ performance. 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 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.
