Is Cognizant Technology Solutions Corporation's (NASDAQ:CTSH) Recent Stock Performance Influenced By Its Fundamentals In Any Way?
Most readers would already be aware that Cognizant Technology Solutions' (NASDAQ:CTSH) stock increased significantly by 17% 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 study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Cognizant Technology Solutions' 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.
See our latest analysis for Cognizant Technology Solutions
How To Calculate Return On Equity?
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$1.9b ÷ US$12b (Based on the trailing twelve months to September 2021).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.16 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.
Cognizant Technology Solutions' Earnings Growth And 16% ROE
To start with, Cognizant Technology Solutions' ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 17%. Given the circumstances, we can't help but wonder why Cognizant Technology Solutions saw little to no growth in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.
We then compared Cognizant Technology Solutions' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 15% in the same period, which is a bit concerning.
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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 26% (meaning the company retains74% of profits) in the last three-year period, Cognizant Technology Solutions' earnings growth was more or les flat. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Additionally, Cognizant Technology Solutions has paid dividends over a period of five years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 21% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
Summary
Overall, we feel that Cognizant Technology Solutions certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. 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.
