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Cadence Design Systems (NASDAQ:CDNS) has had a great run on the share market with its stock up by a significant 23% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Cadence Design Systems' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Cadence Design Systems
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 Cadence Design Systems is:
23% = US$1.0b ÷ US$4.6b (Based on the trailing twelve months to September 2024).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.23.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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 Cadence Design Systems' Earnings Growth And 23% ROE
To begin with, Cadence Design Systems has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. This likely paved the way for the modest 5.9% net income growth seen by Cadence Design Systems over the past five years.
We then compared Cadence Design Systems' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 20% in the same 5-year period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Cadence Design Systems''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.