Amdocs (NASDAQ:DOX) has had a rough three months with its share price down 10.0%. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Amdocs' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To Calculate Return On Equity?

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 Amdocs is:

15% = US$531m ÷ US$3.6b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.15 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Amdocs' Earnings Growth And 15% ROE

To begin with, Amdocs seems to have a respectable ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. Yet, Amdocs has posted measly growth of 3.8% over the past five years. 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. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Amdocs' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 12% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Amdocs fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Amdocs Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 35% (or a retention ratio of 65% over the past three years, Amdocs has seen very little growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Amdocs has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. 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 28%. However, Amdocs' ROE is predicted to rise to 20% despite there being no anticipated change in its payout ratio.

Summary

On the whole, we do feel that Amdocs has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.