Yahoo Finance Cognizant Technology Solutions Corporation's (NASDAQ:CTSH) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?
With its stock down 11% over the past three months, it is easy to disregard Cognizant Technology Solutions (NASDAQ:CTSH). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Cognizant Technology Solutions' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Cognizant Technology Solutions
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 Cognizant Technology Solutions is:
16% = US$2.1b ÷ US$13b (Based on the trailing twelve months to December 2023).
The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.16 in profit.
Why Is ROE Important For 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. 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. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. However, for some reason, the higher returns aren't reflected in Cognizant Technology Solutions' meagre five year net income growth average of 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.
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 14% in the same 5-year period, which is a bit concerning.
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. This then helps them determine if the stock is placed for a bright or bleak future. What is CTSH worth today? The intrinsic value infographic in our free research report helps visualize whether CTSH is currently mispriced by the market.
Is Cognizant Technology Solutions Efficiently Re-investing Its Profits?
Despite having a normal three-year median payout ratio of 26% (or a retention ratio of 74% over the past three years, Cognizant Technology Solutions has seen very little growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Moreover, Cognizant Technology Solutions has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings 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. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.
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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.
