Declining Stock and Solid Fundamentals: Is The Market Wrong About Pegasystems Inc. (NASDAQ:PEGA)?

Pegasystems (NASDAQ:PEGA) has had a rough three months with its share price down 35%. 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. Particularly, we will be paying attention to Pegasystems' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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How Do You 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 Pegasystems is:

17% = US$99m ÷ US$585m (Based on the trailing twelve months to December 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.17 in profit.

View our latest analysis for Pegasystems

Why Is ROE Important For 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 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.

Pegasystems' Earnings Growth And 17% ROE

To start with, Pegasystems' ROE looks acceptable. Even when compared to the industry average of 14% the company's ROE looks quite decent. This probably goes some way in explaining Pegasystems' moderate 19% growth over the past five years amongst other factors.

As a next step, we compared Pegasystems' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 20% in the same period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Pegasystems''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Pegasystems Efficiently Re-investing Its Profits?

In Pegasystems' case, its respectable earnings growth can probably be explained by its low LTM (or last twelve month) payout ratio of 10% (or a retention ratio of 90%), which suggests that the company is investing most of its profits to grow its business.

Besides, Pegasystems has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 3.6% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Summary

Overall, we are quite pleased with Pegasystems' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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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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.