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Should Weakness in Cognizant Technology Solutions Corporation's (NASDAQ:CTSH) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

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With its stock down 16% over the past three months, it is easy to disregard Cognizant Technology Solutions (NASDAQ:CTSH). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Cognizant Technology Solutions' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Cognizant Technology Solutions

How Do You 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 Cognizant Technology Solutions is:

18% = US$2.2b ÷ US$12b (Based on the trailing twelve months to March 2022).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.18 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Cognizant Technology Solutions' Earnings Growth And 18% ROE

To start with, Cognizant Technology Solutions' ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 17%. However, we are curious as to how Cognizant Technology Solutions' decent returns still resulted in flat growth for Cognizant Technology Solutions in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

As a next step, we compared Cognizant Technology Solutions' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 15% in the same period.

past-earnings-growth
past-earnings-growth

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Cognizant Technology Solutions fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Cognizant Technology Solutions Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 26% (implying that the company keeps 74% of its income) over the last three years, Cognizant Technology Solutions has seen a negligible amount of growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Cognizant Technology Solutions has paid dividends over a period of five years, which means that the company's management is determined to pay dividends even if it means little to no earnings 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 21%. Accordingly, forecasts suggest that Cognizant Technology Solutions' future ROE will be 19% which is again, similar to the current ROE.

Conclusion

Overall, we feel that Cognizant Technology Solutions certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

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