Technology One Limited (ASX:TNE) stock has recently shown weakness, but financials look solid: should potential shareholders take the plunge?
It’s hard to get excited after watching the recent performance of Technology One (ASX:TNE), as its stock has fallen 9.2% over the past month. However, a closer look at his healthy finances might make you think again. Since fundamentals generally determine long-term market outcomes, the company is worth looking into. In particular, we will be paying attention to Technology One’s ROE today.
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
See our latest analysis for Technology One
How is ROE calculated?
ROE can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Technology One is:
38% = AU$73 million ÷ AU$190 million (based on trailing 12 months to September 2021).
The “yield” is the profit of the last twelve months. One way to conceptualize this is that for every Australian dollar of share capital it has, the company has made a profit of 0.38 Australian dollars.
Why is ROE important for earnings growth?
So far we have learned that ROE is a measure of a company’s profitability. We now need to assess how much profit the company is reinvesting or “retaining” for future growth, which then gives us an idea of the company’s growth potential. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.
A side-by-side comparison of Technology One’s earnings growth and 38% ROE
First, we recognize that Technology One has a significantly high ROE. Additionally, the company’s ROE is above the industry average of 11%, which is quite remarkable. This likely laid the foundation for Technology One’s moderate 15% net income growth over the past five years.
We then performed a comparison between Technology One’s net income growth and that of the industry, which revealed that the company’s growth is similar to the industry average growth of 18% over the same period.
Earnings growth is an important factor in stock valuation. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. This then helps them determine if the stock is positioned for a bright or bleak future. Has the market priced in TNE’s future prospects? You can find out in our latest infographic research report on intrinsic value.
Is Technology One effectively using its retained earnings?
Technology One has a significant three-year median payout ratio of 65%, meaning it only has 35% left to reinvest in its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its earnings to shareholders.
Additionally, Technology One has paid dividends over a period of at least ten years, which means the company is pretty serious about sharing its profits with its shareholders. After reviewing the latest analyst consensus data, we found that the company is expected to continue to pay out around 60% of its earnings over the next three years. As a result, Technology One’s ROE is not expected to change much either, which we infer from analysts’ estimate of 37% for future ROE.
Overall, we’re pretty happy with Technology One’s performance. In particular, its high ROE is quite remarkable and also the likely explanation for its considerable earnings growth. Yet the company retains a small portion of its profits. Which means the company was able to increase its profits despite this, so it’s not that bad. The latest forecasts from industry analysts show that the company should maintain its current growth rate. Are these analyst expectations based on general industry expectations or company fundamentals? Click here to access our analyst forecast page for the company.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.