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Palo Alto Networks (NASDAQ:PANW) has had a great run on the share market with its stock up by a significant 12% 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. Specifically, we decided to study Palo Alto Networks' ROE in this article.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Palo Alto Networks
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 Palo Alto Networks is:
28% = US$614m ÷ US$2.2b (Based on the trailing twelve months to October 2023).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.28 in profit.
What Has ROE Got To Do With 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. 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.
Palo Alto Networks' Earnings Growth And 28% ROE
Firstly, we acknowledge that Palo Alto Networks has a significantly high ROE. Secondly, even when compared to the industry average of 9.7% the company's ROE is quite impressive. As a result, Palo Alto Networks' exceptional 23% net income growth seen over the past five years, doesn't come as a surprise.
As a next step, we compared Palo Alto Networks' 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 18%.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is PANW fairly valued? This infographic on the company's intrinsic value has everything you need to know.