Technology One Limited's (ASX:TNE) Recent Stock Performance Looks Decent- Can Strong Fundamentals Be the Reason?

Technology One's (ASX:TNE) stock up by 9.8% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Technology One's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Technology One

How Is ROE Calculated?

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:

34% = AU$103m ÷ AU$306m (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings 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$0.34 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

A Side By Side comparison of Technology One's Earnings Growth And 34% ROE

To begin with, Technology One has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 9.5% which is quite remarkable. So, the substantial 21% net income growth seen by Technology One over the past five years isn't overly surprising.

As a next step, we compared Technology One's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 25% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Technology One fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Technology One Efficiently Re-investing Its Profits?

Technology One's significant three-year median payout ratio of 59% (where it is retaining only 41% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Moreover, Technology One is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 56%. Accordingly, forecasts suggest that Technology One's future ROE will be 33% which is again, similar to the current ROE.

Summary

Overall, we are quite pleased with Technology One's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.