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Analog Devices (NASDAQ:ADI) has had a great run on the share market with its stock up by a significant 27% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Analog Devices' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Analog Devices
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 Analog Devices is:
10% = US$1.2b ÷ US$12b (Based on the trailing twelve months to October 2020).
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 $0.10.
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. 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 Analog Devices' Earnings Growth And 10% ROE
To start with, Analog Devices' ROE looks acceptable. Even when compared to the industry average of 11% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 15% seen over the past five years by Analog Devices.
Next, on comparing Analog Devices' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 15% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. Is ADI fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Analog Devices Efficiently Re-investing Its Profits?
While Analog Devices has a three-year median payout ratio of 60% (which means it retains 40% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.