Most readers would already be aware that Telecom Plus' (LON:TEP) stock increased significantly by 28% 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 Telecom Plus' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Telecom Plus

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 Telecom Plus is:

16% = UK£36m ÷ UK£222m (Based on the trailing twelve months to March 2020).

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 £0.16 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learnt 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. 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.

Telecom Plus' Earnings Growth And 16% ROE

At first glance, Telecom Plus seems to have a decent ROE. On comparing with the average industry ROE of 8.6% the company's ROE looks pretty remarkable. However, for some reason, the higher returns aren't reflected in Telecom Plus' meagre five year net income growth average of 2.4%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, on comparing with the industry net income growth, we found that Telecom Plus' reported growth was lower than the industry growth of 8.4% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. What is TEP worth today? The intrinsic value infographic in our free research report helps visualize whether TEP is currently mispriced by the market.