Tecsys Inc.'s (TSE:TCS) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Most readers would already be aware that Tecsys' (TSE:TCS) stock increased significantly by 30% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Tecsys' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Tecsys

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 Tecsys is:

5.3% = CA$2.1m ÷ CA$39m (Based on the trailing twelve months to January 2020).

The 'return' is the yearly profit. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.05 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learnt that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Tecsys' Earnings Growth And 5.3% ROE

At first glance, Tecsys' ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 21%. Given the circumstances, the significant decline in net income by 9.0% seen by Tecsys over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

However, when we compared Tecsys' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 11% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Tecsys is trading on a high P/E or a low P/E, relative to its industry.

Is Tecsys Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 34% (or a retention ratio of 66%) which is pretty normal, Tecsys' declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Tecsys has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

On the whole, we feel that the performance shown by Tecsys can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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. 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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