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It is hard to get excited after looking at Illumina's (NASDAQ:ILMN) recent performance, when its stock has declined 18% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Illumina's 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.
See our latest analysis for Illumina
How To Calculate Return On Equity?
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 Illumina is:
13% = US$630m ÷ US$4.9b (Based on the trailing twelve months to April 2021).
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 $0.13 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Illumina's Earnings Growth And 13% ROE
At first glance, Illumina seems to have a decent ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 17%. However, the moderate 9.0% net income growth seen by Illumina over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also provides some context to the earnings growth seen by the company.
Next, on comparing with the industry net income growth, we found that Illumina's reported growth was lower than the industry growth of 20% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. 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 Illumina fairly valued compared to other companies? These 3 valuation measures might help you decide.