Most readers would already be aware that Cisco Systems' (NASDAQ:CSCO) stock increased significantly by 5.2% over the past week. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Cisco Systems' 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 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 Cisco Systems is:
27% = US$11b ÷ US$42b (Based on the trailing twelve months to April 2023).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.27 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
A Side By Side comparison of Cisco Systems' Earnings Growth And 27% ROE
First thing first, we like that Cisco Systems has an impressive ROE. Secondly, even when compared to the industry average of 10% the company's ROE is quite impressive. Probably as a result of this, Cisco Systems was able to see a decent net income growth of 15% over the last five years.
As a next step, we compared Cisco Systems' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 32% in the same period.
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. What is CSCO worth today? The intrinsic value infographic in our free research report helps visualize whether CSCO is currently mispriced by the market.
Is Cisco Systems Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 54% (or a retention ratio of 46%) for Cisco Systems suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Moreover, Cisco Systems is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 37% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.
On the whole, we do feel that Cisco Systems has some positive attributes. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. 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 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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