Declining Stock and Decent Financials: Is The Market Wrong About Cognizant Technology Solutions Corporation (NASDAQ:CTSH)?
With its stock down 5.2% 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. Specifically, we decided to study Cognizant Technology Solutions' ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Check out our latest analysis for Cognizant Technology Solutions
How To Calculate Return On Equity?
Return on equity 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:
20% = US$2.3b ÷ US$12b (Based on the trailing twelve months to September 2022).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.20.
What Is The Relationship Between ROE And 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. 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.
Cognizant Technology Solutions' Earnings Growth And 20% ROE
At first glance, Cognizant Technology Solutions seems to have a decent ROE. Especially when compared to the industry average of 15% the company's ROE looks pretty impressive. Yet, Cognizant Technology Solutions has posted measly growth of 4.7% over the past five years. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like 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.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Cognizant Technology Solutions fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Cognizant Technology Solutions Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 26% (implying that the company retains the remaining 74% of its income), Cognizant Technology Solutions' earnings growth was quite low. 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 six 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 over the next three years is expected to be approximately 23%. Accordingly, forecasts suggest that Cognizant Technology Solutions' future ROE will be 18% which is again, similar to the current ROE.
Summary
Overall, we feel that Cognizant Technology Solutions certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
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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.
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