Does The Market Have A Low Tolerance For Telecom Plus PLC's (LON:TEP) Mixed Fundamentals?

It is hard to get excited after looking at Telecom Plus' (LON:TEP) recent performance, when its stock has declined 11% 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. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Telecom Plus' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Telecom Plus

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 Telecom Plus is:

17% = UK£37m ÷ UK£216m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.17.

Why Is ROE Important For 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.

A Side By Side comparison of Telecom Plus' Earnings Growth And 17% ROE

To begin with, Telecom Plus seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.0%. Despite this, Telecom Plus' five year net income growth was quite low averaging at only 4.5%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. 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 found that the company's growth figure is lower than the average industry growth rate of 7.9% in the same period, which is a bit concerning.

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 TEP fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Telecom Plus Making Efficient Use Of Its Profits?

Telecom Plus' very high three-year median payout ratio of 125% suggests that the company is paying its shareholders more than what it is earning and it definitely contributes to the low earnings growth seen by the company. That's a huge risk in our books.

In addition, Telecom Plus has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. 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 105%.

Summary

Overall, we have mixed feelings about Telecom Plus. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Telecom Plus' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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This article by Simply Wall St is general in nature. 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.
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