Are Strong Financial Prospects The Force That Is Driving The Momentum In Cognizant Technology Solutions Corporation's NASDAQ:CTSH) Stock?

Simply Wall St

Sat, Sep 2, 2023, 5:00 AM 4 min read

Cognizant Technology Solutions' (NASDAQ:CTSH) stock is up by a considerable 13% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Cognizant Technology Solutions' ROE.

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.

Check out our latest analysis for Cognizant Technology Solutions

How Do You Calculate Return On Equity?

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:

17% = US$2.2b ÷ US$13b (Based on the trailing twelve months to June 2023).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.17 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. 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.

A Side By Side comparison of Cognizant Technology Solutions' Earnings Growth And 17% ROE

To start with, Cognizant Technology Solutions' ROE looks acceptable. Even when compared to the industry average of 16% the company's ROE looks quite decent. This certainly adds some context to Cognizant Technology Solutions' moderate 6.1% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Cognizant Technology Solutions' reported growth was lower than the industry growth of 23% over the last few years, which is not something we like to see.

past-earnings-growth — NasdaqGS:CTSH Past Earnings Growth September 2nd 2023

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is CTSH fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Cognizant Technology Solutions Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 26% (implying that the company retains 74% 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.

Additionally, Cognizant Technology Solutions has paid dividends over a period of six years which means that the company is pretty serious about sharing its profits with shareholders. 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 25%. As a result, Cognizant Technology Solutions' ROE is not expected to change by much either, which we inferred from the analyst estimate of 18% for future ROE.

Summary

On the whole, we feel that Cognizant Technology Solutions' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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.

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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.