Do Its Financials Have Any Role To Play In Driving TPG Telecom Limited's (ASX:TPG) Stock Up Recently?

TPG Telecom (ASX:TPG) has had a great run on the share market with its stock up by a significant 7.5% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study TPG Telecom's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for TPG Telecom

How Do You Calculate Return On Equity?

ROE 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 TPG Telecom is:

3.3% = AU$394m ÷ AU$12b (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.03.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

A Side By Side comparison of TPG Telecom's Earnings Growth And 3.3% ROE

It is quite clear that TPG Telecom's ROE is rather low. Even when compared to the industry average of 6.4%, the ROE figure is pretty disappointing. In spite of this, TPG Telecom was able to grow its net income considerably, at a rate of 40% in the last five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing TPG Telecom's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 40% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 TPG Telecom is trading on a high P/E or a low P/E, relative to its industry.

Is TPG Telecom Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 85% (implying that it keeps only 15% of profits) for TPG Telecom suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Additionally, TPG Telecom has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 121% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 2.5% over the same period.

Summary

On the whole, we do feel that TPG Telecom has some positive attributes. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. 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.