Is Applied Materials, Inc.'s(NASDAQ:AMAT) Recent Stock Performance Tethered To Its Strong Fundamentals?
Most readers would already be aware that Applied Materials' (NASDAQ:AMAT) stock increased significantly by 42% over the past 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. Particularly, we will be paying attention to Applied Materials' ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Applied Materials
How Do You 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 Applied Materials is:
34% = US$3.6b ÷ US$11b (Based on the trailing twelve months to October 2020).
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 $0.34.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
A Side By Side comparison of Applied Materials' Earnings Growth And 34% ROE
First thing first, we like that Applied Materials has an impressive ROE. Secondly, even when compared to the industry average of 11% the company's ROE is quite impressive. This probably laid the groundwork for Applied Materials' moderate 15% net income growth seen over the past five years.
We then performed a comparison between Applied Materials' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 15% in the same period.
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. Doing so will help them establish if the stock's future looks promising or ominous. What is AMAT worth today? The intrinsic value infographic in our free research report helps visualize whether AMAT is currently mispriced by the market.
Is Applied Materials Efficiently Re-investing Its Profits?
In Applied Materials' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 23% (or a retention ratio of 77%), which suggests that the company is investing most of its profits to grow its business.
Additionally, Applied Materials has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 26%. Accordingly, forecasts suggest that Applied Materials' future ROE will be 30% which is again, similar to the current ROE.
Summary
Overall, we are quite pleased with Applied Materials' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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