Tetra Tech's (NASDAQ:TTEK) stock is up by 7.2% over the past three months. Since the market usually pay for a company's long-term financial health, we decided to study the company's fundamentals to see if they could be influencing the market. In this article, we decided to focus on Tetra Tech's ROE.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Tetra Tech

How Do You Calculate Return On Equity?

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:

19% = US$273m ÷ US$1.4b (Based on the trailing twelve months to October 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.19.

Why Is ROE Important For 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. 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.

Tetra Tech's Earnings Growth And 19% ROE

To begin with, Tetra Tech seems to have a respectable ROE. On comparing with the average industry ROE of 8.1% the company's ROE looks pretty remarkable. This certainly adds some context to Tetra Tech's decent 17% 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 8.6% 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. 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 Making Efficient Use Of 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.

Summary

Overall, we are quite pleased with Tetra Tech's performance. 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. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.