It’s hard to get excited after looking at Tech Mahindra’s (NSE: TECHM ) recent performance, when its shares have fallen 8.3% over the past three months. However, share prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In particular, today we will pay attention to Tech Mahindra’s ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is using the company’s capital. In other words, it is a profitability ratio that measures the rate of return on capital provided by the company’s shareholders.
Check out our latest analysis for Tech Mahindra
How do you calculate return on equity?
The formula for ROE is:
Return on equity = net profit (from continuing operations) ÷ Shareholder’s equity
So, based on the above formula, the ROE for Tech Mahindra is:
20% = ₹ 54b ÷ ₹ 274b (based on trailing twelve months to June 2022).
‘Yield’ is annual profit. This means that for every ₹1 worth of equity, the company made ₹0.20 in profit.
Why is ROE important to earnings growth?
So far we have learned that ROE is a measure of a company’s profitability. Now we need to estimate how much profit the company is reinvesting or “holding back” for future growth which then gives us an idea of the company’s growth potential. In general, other things being equal, firms with a high return on equity and retained earnings have a higher growth rate than firms that do not share these attributes.
Tech Mahindra earnings growth and ROE of 20%.
At first glance, Tech Mahindra appears to have a decent ROE. Especially compared to the industry average of 14% the company’s ROE looks quite impressive. This probably laid the foundation for Tech Mahindra’s moderate net income growth of 9.3% over the past five years.
Then, when compared to the industry net income growth, we found that Tech Mahindra reported growth less than the industry growth of 16% over the same period, which is not something we like to see.
The basis for assigning value to a company is largely tied to its earnings growth. The investor should try to determine whether the expected growth or decline in earnings, as the case may be, is factored into the price. That way, they will have an idea whether the action is going into clear blue waters or swampy waters await them. Is Tech Mahindra fairly valued compared to other companies? These 3 evaluation measures can help you decide.
Is Tech Mahindra using its retained earnings effectively?
Tech Mahindra has a three-year median payout ratio of 26%, implying that it retains the remaining 74% of its profits. This suggests that the dividend is well covered, and given the decent growth the company has seen, management seems to be effectively reinvesting its earnings.
Additionally, Tech Mahindra has been paying dividends for at least ten years, which means the company is quite serious about sharing profits with shareholders. Looking at current analyst consensus data, we can see that the company’s future payout ratio is expected to rise to 62% over the next three years. Nonetheless, ROE is not expected to change much for the company despite the higher expected payout ratio.
Overall, we feel that Tech Mahindra’s performance has been quite good. It is especially great to see that the company invests a lot in its business and that with a high rate of return this has resulted in a respectable growth in its earnings. That being the case, the latest analyst forecasts indicate that the company will continue to see its earnings expand. To learn more about the latest analyst forecasts for the company, view this visualization of analyst forecasts for the company.
Valuation is complex, but we help make it simple.
Find out if Tech Mahindra is potentially overstated or understated by checking our comprehensive analysis, which includes fair value estimates, risks and caveats, dividends, insider transactions and financial condition.
Check out the free analysis
Have feedback on this article? Worried about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplevallst.com.
This Simply Wall St article 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 into account your goals or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest company announcements that are price sensitive or qualitative material. Simpli Wall St has no position in any of the stocks mentioned.