Most readers would already be aware that Tetra Tech’s (NASDAQ:TTEK) stock increased significantly by 20% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Tetra Tech’s 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
Return on equity 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 Tetra Tech is:
16% = US$179m ÷ US$1.1b (Based on the trailing twelve months to December 2020).
The ‘return’ is the yearly profit. That means that for every $1 worth of shareholders’ equity, the company generated $0.16 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don’t have the same features.
A Side By Side comparison of Tetra Tech’s Earnings Growth And 16% ROE
At first glance, Tetra Tech seems to have a decent ROE. On comparing with the average industry ROE of 8.3% the company’s ROE looks pretty remarkable. Probably as a result of this, Tetra Tech was able to see an impressive net income growth of 22% over the last five years. However, there could also be other causes behind this growth. 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.
We then compared Tetra Tech’s 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 9.3% in the same period.
Earnings growth is a huge factor in stock valuation. 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. 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 Tetra Tech is trading on a high P/E or a low P/E, relative to its industry.
Is Tetra Tech Efficiently…
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