Are Telstra Group Limited's (ASX:TLS) Mixed Financials The Reason For Its Gloomy Performance on The Stock Market?

It is hard to get excited after looking at Telstra Group's (ASX:TLS) recent performance, when its stock has declined 7.6% over the past three months. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Telstra Group's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Telstra Group

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 Telstra Group is:

12% = AU$2.2b ÷ AU$18b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.12 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.

Telstra Group's Earnings Growth And 12% ROE

At first glance, Telstra Group seems to have a decent ROE. On comparing with the average industry ROE of 5.2% the company's ROE looks pretty remarkable. As you might expect, the 6.4% net income decline reported by Telstra Group is a bit of a surprise. Therefore, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

That being said, we compared Telstra Group's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 20% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. What is TLS worth today? The intrinsic value infographic in our free research report helps visualize whether TLS is currently mispriced by the market.

Is Telstra Group Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 94% (implying that 6.0% of the profits are retained), most of Telstra Group's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 2 risks we have identified for Telstra Group by visiting our risks dashboard for free on our platform here.

Additionally, Telstra Group has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 97% of its profits over the next three years. Regardless, the future ROE for Telstra Group is predicted to rise to 15% despite there being not much change expected in its payout ratio.

Summary

In total, we're a bit ambivalent about Telstra Group's performance. While the company does have a high rate of return, its low earnings retention is probably what's 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. 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.