Most readers would already be aware that Telecom Plus' (LON:TEP) stock increased significantly by 28% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Telecom Plus' ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You Calculate Return On Equity?
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:
16% = UK£36m ÷ UK£222m (Based on the trailing twelve months to March 2020).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.16 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Telecom Plus' Earnings Growth And 16% ROE
At first glance, Telecom Plus seems to have a decent ROE. On comparing with the average industry ROE of 8.6% the company's ROE looks pretty remarkable. However, for some reason, the higher returns aren't reflected in Telecom Plus' meagre five year net income growth average of 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. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Next, on comparing with the industry net income growth, we found that Telecom Plus' reported growth was lower than the industry growth of 8.4% in the same period, 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. What is TEP worth today? The intrinsic value infographic in our free research report helps visualize whether TEP is currently mispriced by the market.
Is Telecom Plus Using Its Retained Earnings Effectively?
Telecom Plus has a very high three-year median payout ratio of 126%suggesting that the company's shareholders are getting paid from more than just the company's income. This is indicative of risk. Our risks dashboard should have the 3 risks we have identified for Telecom Plus.
Additionally, Telecom Plus has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 93% over the next three years. The fact that the company's ROE is expected to rise to 26% over the same period is explained by the drop in the payout ratio.
Overall, we have mixed feelings about Telecom Plus. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.com.
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. Thank you for reading.