It’s hard to get excited after looking at the recent performance of Tech Mahindra (NSE: TECHM ), when its shares have fallen 10% in the last three months. But if you pay close attention, you might realize that its strong financials could mean the stock could potentially see appreciation over the long term, given how markets tend to reward companies with good financial health. In this article, we have decided to focus on Tech Mahindra’s ROE.
Return on equity or ROE is an important factor for a shareholder to consider because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess a company’s profitability relative to its equity.
Check out our latest analysis for Tech Mahindra
How do you calculate return on equity?
The formula for return on equity 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 ÷ ₹272b (based on trailing twelve months to September 2022).
‘Yield’ is earnings over the last twelve months. So it means that for every ₹1 invested by its shareholder, the company generates a profit of ₹0.20.
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. All else being equal, companies that have both a higher return on equity and a higher profit retention tend to be those that have a higher growth rate compared to companies that do not have the same characteristics.
Side by Side Comparison of Tech Mahindra’s Earnings Growth and 20% ROE
For starters, Tech Mahindra seems to have a respectable ROE. Further, the company’s ROE is quite favorable compared to the industry average of 13%. This certainly adds some context to Tech Mahindra’s decent net income growth of 8.5% over the past five years.
As a next step, we compared Tech Mahindra’s net income growth to the industry and were disappointed to see that the company’s growth was lower than the industry average growth of 16% over the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is whether the expected earnings growth, or lack thereof, is already built into the stock price. This will help them determine whether the future of the stock looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio, which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you might want to check whether Tech Mahindra is trading at a high P/E or a low P/E, relative to its industry.
Is Tech Mahindra using its profits 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 its dividend is well covered, and given the decent growth the company has seen, management seems to be effectively reinvesting its earnings.
Besides, Tech Mahindra has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the company’s forward payout ratio is expected to rise to 66% over the next three years. However, the company’s ROE is not expected to change much despite the higher expected payout ratio.
Overall, we feel that Tech Mahindra’s performance has been quite good. We especially like that the company is reinvesting in its business with a high rate of return. As a result, the decent growth of his earnings is not surprising. Additionally, the latest forecasts from industry analysts reveal that the company’s earnings are expected to accelerate. To learn more about the company’s future earnings growth forecasts, check this out free analyst forecast report for the company to learn more.
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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 price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.