Cognizant Technology Solutions Corporation (NASDAQ:CTSH) On An Uptrend: Could Fundamentals Be Driving The Stock?
Cognizant Technology Solutions' (NASDAQ:CTSH) stock is up by 8.9% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. 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?
ROE 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 Cognizant Technology Solutions is:
16% = US$2.1b ÷ US$13b (Based on the trailing twelve months to December 2023).
The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.16 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 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.
Cognizant Technology Solutions' Earnings Growth And 16% ROE
At first glance, Cognizant Technology Solutions seems to have a decent ROE. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. Despite this, Cognizant Technology Solutions' five year net income growth was quite low averaging at only 4.1%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing with the industry net income growth, we found that Cognizant Technology Solutions' reported growth was lower than the industry growth of 17% over the last few years, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for CTSH? You can find out in our latest intrinsic value infographic research report.
Is Cognizant Technology Solutions Making Efficient Use Of Its Profits?
Despite having a moderate three-year median payout ratio of 26% (implying that the company retains the remaining 74% of its income), Cognizant Technology Solutions' earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Cognizant Technology Solutions has been paying dividends over a period of seven years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 25% of its profits over the next three years. Accordingly, forecasts suggest that Cognizant Technology Solutions' future ROE will be 16% which is again, similar to the current ROE.
Summary
On the whole, we do feel that Cognizant Technology Solutions has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
