Tera Software Limited's (NSE:TERASOFT) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Tera Software's (NSE:TERASOFT) stock is up by a considerable 170% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Tera Software's 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Tera Software

How Is ROE Calculated?

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 Tera Software is:

5.8% = ₹68m ÷ ₹1.2b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.06 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. 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 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.

Tera Software's Earnings Growth And 5.8% ROE

It is quite clear that Tera Software's ROE is rather low. Even compared to the average industry ROE of 13%, the company's ROE is quite dismal. Therefore, the disappointing ROE therefore provides a background to Tera Software's very little net income growth of 3.8% over the past five years.

As a next step, we compared Tera Software's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 25% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Tera Software fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Tera Software Making Efficient Use Of Its Profits?

Tera Software doesn't pay any regular dividends, meaning that potentially all of its profits are being reinvested in the business. However, this doesn't explain the low earnings growth the company has seen. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Summary

On the whole, we feel that the performance shown by Tera Software can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 2 risks we have identified for Tera Software by visiting our risks dashboard for free on our platform here.

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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.