Can Mixed Financials Have A Negative Impact on TE Connectivity Ltd.'s 's (NYSE:TEL) Current Price Momentum?
Most readers would already know that TE Connectivity's (NYSE:TEL) stock increased by 1.2% over the past month. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. Particularly, we will be paying attention to TE Connectivity's 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for TE Connectivity
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for TE Connectivity is:
0.9% = US$93m ÷ US$10.0b (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.01 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
TE Connectivity's Earnings Growth And 0.9% ROE
It is quite clear that TE Connectivity's ROE is rather low. Even when compared to the industry average of 11%, the ROE figure is pretty disappointing. For this reason, TE Connectivity's five year net income decline of 11% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
However, when we compared TE Connectivity's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 11% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. 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. If you're wondering about TE Connectivity's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is TE Connectivity Using Its Retained Earnings Effectively?
In spite of a normal three-year median payout ratio of 31% (that is, a retention ratio of 69%), the fact that TE Connectivity's earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, TE Connectivity 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. 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. Still, forecasts suggest that TE Connectivity's future ROE will rise to 21% even though the the company's payout ratio is not expected to change by much.
Conclusion
On the whole, we feel that the performance shown by TE Connectivity can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.
This article by Simply Wall St is general in nature. 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.
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