With its stock down 3.2% over the past three months, it is easy to disregard TPG Telecom (ASX:TPG). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to TPG Telecom's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for TPG Telecom

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 TPG Telecom is:

0.9% = AU$110m ÷ AU$12b (Based on the trailing twelve months to December 2021).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.01 in profit.

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. 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.

A Side By Side comparison of TPG Telecom's Earnings Growth And 0.9% ROE

As you can see, TPG Telecom's ROE looks pretty weak. Not just that, even compared to the industry average of 3.9%, the company's ROE is entirely unremarkable. Despite this, surprisingly, TPG Telecom saw an exceptional 45% net income growth over the past five years. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared TPG Telecom's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 26%.

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. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if TPG Telecom is trading on a high P/E or a low P/E, relative to its industry.