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Broadcom (NASDAQ:AVGO) has had a great run on the share market with its stock up by a significant 41% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Broadcom's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Broadcom
How Do You 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 Broadcom is:
9.1% = US$6.2b ÷ US$68b (Based on the trailing twelve months to November 2024).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.09.
Why Is ROE Important For 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 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.
Broadcom's Earnings Growth And 9.1% ROE
At first glance, Broadcom's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 11%, we may spare it some thought. Particularly, the exceptional 26% net income growth seen by Broadcom over the past five years is pretty remarkable. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared Broadcom's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 20%.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Broadcom is trading on a high P/E or a low P/E, relative to its industry.