Do Fundamentals Have Any Role To Play In Driving Telecom Plus Plc's (LON:TEP) Stock Up Recently?

Telecom Plus' (LON:TEP) stock is up by 4.8% over the past week. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. In this article, we decided to focus on Telecom Plus' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Telecom Plus

How Do You 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 Telecom Plus is:

15% = UK£30m ÷ UK£204m (Based on the trailing twelve months to September 2021).

The 'return' is the amount earned after tax over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.15 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Telecom Plus' Earnings Growth And 15% ROE

To start with, Telecom Plus' ROE looks acceptable. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. Despite this, Telecom Plus' five year net income growth was quite low averaging at only 3.0%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

We then compared Telecom Plus' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 2.2% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for TEP? You can find out in our latest intrinsic value infographic research report.

Is Telecom Plus Efficiently Re-investing Its Profits?

Telecom Plus has a very high three-year median payout ratio of 125%suggesting that the company's shareholders are getting paid from more than just the company's income. This is quite a risky position to be in. To know the 2 risks we have identified for Telecom Plus visit our risks dashboard for free.

Moreover, Telecom Plus has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 90% over the next three years. Regardless, the future ROE for Telecom Plus is predicted to decline to 5.6% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.

Summary

In total, it does look like Telecom Plus has some positive aspects to its business. Especially the growth in earnings which was backed by an impressive ROE. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be negligible. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.