Could The Market Be Wrong About Cognizant Technology Solutions Corporation (NASDAQ:CTSH) Given Its Attractive Financial Prospects?

It is hard to get excited after looking at Cognizant Technology Solutions' (NASDAQ:CTSH) recent performance, when its stock has declined 2.4% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Cognizant Technology Solutions' ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Cognizant Technology Solutions is:

16% = US$2.4b ÷ US$15b (Based on the trailing twelve months to March 2025).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.16 in profit.

Check out our latest analysis for Cognizant Technology Solutions

What Has ROE Got To Do With 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Cognizant Technology Solutions' Earnings Growth And 16% ROE

To begin with, Cognizant Technology Solutions seems to have a respectable ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. This certainly adds some context to Cognizant Technology Solutions' decent 7.8% net income growth seen over the past five years.

We then compared Cognizant Technology Solutions' 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 2.5% in the same 5-year period.

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. What is CTSH worth today? The intrinsic value infographic in our free research report helps visualize whether CTSH is currently mispriced by the market.

Is Cognizant Technology Solutions Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 27% (implying that the company retains 73% of its profits), it seems that Cognizant Technology Solutions is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Cognizant Technology Solutions is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. 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 23%. Accordingly, forecasts suggest that Cognizant Technology Solutions' future ROE will be 15% which is again, similar to the current ROE.

Conclusion

Overall, we are quite pleased with Cognizant Technology Solutions' 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 sizeable growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.