With its stock down 8.7% over the past month, it is easy to disregard Tetra Tech (NASDAQ:TTEK). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. 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 simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Tetra Tech is:
22% = US$263m ÷ US$1.2b (Based on the trailing twelve months to July 2022).
The ‘return’ is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders’ equity, the company generated $0.22 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. We now need to evaluate how much profit the company reinvests or “retains” for future growth which then gives us an idea about the growth potential of the company. 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.
Tetra Tech’s Earnings Growth And 22% ROE
At first glance, Tetra Tech seems to have a decent ROE. Especially when compared to the industry average of 11% the company’s ROE looks pretty impressive. This certainly adds some context to Tetra Tech’s decent 15% net income growth seen over the past five years.
Next, on comparing with the industry net income growth, we found that Tetra Tech’s growth is quite high when compared to the industry average growth of 6.0% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Making Efficient Use Of Its Profits?
Tetra Tech has a low three-year median payout ratio of 19%, meaning that the company retains the remaining 81% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Moreover, Tetra Tech is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. 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 21%. Accordingly, forecasts suggest that Tetra Tech’s future ROE will be 18% which is again, similar to the current ROE.
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. Having said that, the company’s earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.
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