Is Weakness In Technology One Limited (ASX:TNE) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

It is hard to get excited after looking at Technology One's (ASX:TNE) recent performance, when its stock has declined 4.6% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Technology One's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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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 Technology One is:

32% = AU$133m ÷ AU$416m (Based on the trailing twelve months to March 2025).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.32 in profit.

See our latest analysis for Technology One

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. 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.

Technology One's Earnings Growth And 32% ROE

First thing first, we like that Technology One has an impressive ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. This likely paved the way for the modest 16% net income growth seen by Technology One over the past five years.

Next, on comparing Technology One's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 14% over the last few years.

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. Has the market priced in the future outlook for TNE? You can find out in our latest intrinsic value infographic research report.

Is Technology One Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 55% (or a retention ratio of 45%) for Technology One suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, Technology One has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 59%. As a result, Technology One's ROE is not expected to change by much either, which we inferred from the analyst estimate of 35% for future ROE.

Conclusion

In total, we are pretty happy with Technology One's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.