Most readers would already be aware that Infosys' (NSE:INFY) stock increased significantly by 13% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Infosys' ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To 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 Infosys is:
25% = US$2.6b ÷ US$11b (Based on the trailing twelve months to March 2021).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.25 in profit.
Why Is ROE Important For 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. 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.
Infosys' Earnings Growth And 25% ROE
To begin with, Infosys seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.8%. However, for some reason, the higher returns aren't reflected in Infosys' meagre five year net income growth average of 3.1%. 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. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing with the industry net income growth, we found that Infosys' reported growth was lower than the industry growth of 11% in the same period, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Infosys fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Infosys Making Efficient Use Of Its Profits?
Despite having a moderate three-year median payout ratio of 49% (implying that the company retains the remaining 51% of its income), Infosys' earnings growth was quite low. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
In addition, Infosys 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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 63% over the next three years. Regardless, the future ROE for Infosys is speculated to rise to 30% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.
On the whole, we do feel that Infosys has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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