It is hard to get excited after looking at Monolithic Power Systems' (NASDAQ:MPWR) recent performance, when its stock has declined 25% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Monolithic Power Systems' 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 To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Monolithic Power Systems is:
26% = US$391m ÷ US$1.5b (Based on the trailing twelve months to September 2022).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.26.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
A Side By Side comparison of Monolithic Power Systems' Earnings Growth And 26% ROE
To begin with, Monolithic Power Systems has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 19% also doesn't go unnoticed by us. So, the substantial 33% net income growth seen by Monolithic Power Systems over the past five years isn't overly surprising.
Next, on comparing with the industry net income growth, we found that Monolithic Power Systems' growth is quite high when compared to the industry average growth of 26% 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. This then helps them determine if the stock is placed for a bright or bleak future. Is MPWR fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Monolithic Power Systems Making Efficient Use Of Its Profits?
Monolithic Power Systems has a significant three-year median payout ratio of 54%, meaning the company only retains 46% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.
Besides, Monolithic Power Systems has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 22% 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 feel that Monolithic Power Systems' performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. 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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