Most readers would already be aware that Tetra Tech's (NASDAQ:TTEK) stock increased significantly by 22% 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 Tetra Tech's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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:
17% = US$265m ÷ US$1.6b (Based on the trailing twelve months to March 2024).
The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.17 in profit.
What Is The Relationship Between ROE And 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. 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.
Tetra Tech's Earnings Growth And 17% ROE
To start with, Tetra Tech's ROE looks acceptable. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. This probably laid the ground for Tetra Tech's moderate 14% net income growth seen over the past five years.
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 12% in the same 5-year period.
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. Doing so will help them establish if the stock's future looks promising or ominous. Is TTEK fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Tetra Tech Efficiently Re-investing Its Profits?
Tetra Tech has a low three-year median payout ratio of 17%, meaning that the company retains the remaining 83% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Additionally, Tetra Tech has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 14%. Accordingly, forecasts suggest that Tetra Tech's future ROE will be 19% which is again, similar to the current ROE.
Conclusion
On the whole, we feel that Tetra Tech's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.