Could The Market Be Wrong About Tata Consultancy Services Limited (NSE:TCS) Given Its Attractive Financial Prospects?

With its stock down 3.7% over the past month, it is easy to disregard Tata Consultancy Services (NSE:TCS). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Tata Consultancy Services' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Tata Consultancy Services

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 Tata Consultancy Services is:

36% = ₹378b ÷ ₹1.0t (Based on the trailing twelve months to December 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 ₹0.36 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of Tata Consultancy Services' Earnings Growth And 36% ROE

To begin with, Tata Consultancy Services has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. This likely paved the way for the modest 7.1% net income growth seen by Tata Consultancy Services over the past five years. growth

As a next step, we compared Tata Consultancy Services' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 14% in the same period.

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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Tata Consultancy Services''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Tata Consultancy Services Making Efficient Use Of Its Profits?

Tata Consultancy Services has a three-year median payout ratio of 37%, which implies that it retains the remaining 63% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Tata Consultancy Services is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 68% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

Overall, we are quite pleased with Tata Consultancy Services' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.