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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 10% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Cadence Design Systems' ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Cadence Design Systems
How Is ROE Calculated?
ROE can be calculated by using the formula:
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' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.23 in profit.
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 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.
Cadence Design Systems' Earnings Growth And 23% ROE
Firstly, we acknowledge that Cadence Design Systems has a significantly high ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. Probably as a result of this, Cadence Design Systems was able to see a decent net income growth of 5.9% over the last five years.
Next, on comparing with the industry net income growth, we found that Cadence Design Systems' reported growth was lower than the industry growth of 20% over the last few years, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. 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. Is Cadence Design Systems fairly valued compared to other companies? These 3 valuation measures might help you decide.