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Telecom Plus (LON:TEP) has had a great run on the share market with its stock up by a significant 20% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Telecom Plus' ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Telecom Plus is:
17% = UK£35m ÷ UK£206m (Based on the trailing twelve months to March 2022).
The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.17 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Telecom Plus' Earnings Growth And 17% ROE
To begin with, Telecom Plus seems to have a respectable ROE. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. Despite this, Telecom Plus' five year net income growth was quite low averaging at only 2.4%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.
Next, on comparing with the industry net income growth, we found that Telecom Plus' growth is quite high when compared to the industry average growth of 0.6% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for TEP? You can find out in our latest intrinsic value infographic research report.
Is Telecom Plus Making Efficient Use Of Its Profits?
Telecom Plus' very high three-year median payout ratio of 124% suggests that the company is paying its shareholders more than what it is earning and it definitely contributes to the low earnings growth seen by the company. This is indicative of risk.
In addition, Telecom Plus has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 90% over the next three years. However, Telecom Plus' future ROE is expected to decline to 5.6% despite the expected decline in its payout ratio. We infer that there could be other factors that could be steering the foreseen decline in the company's ROE.
On the whole, we do feel that Telecom Plus has some positive attributes. Especially the growth in earnings which was backed by an impressive ROE. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be negligible. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.