Applied Materials''s (NASDAQ:AMAT) stock is up by a considerable 33% 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. In this article, we decided to focus on Applied Materials' ROE.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
Return on equity 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:
32% = US$2.9b ÷ US$9.0b (Based on the trailing twelve months to April 2020).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.32 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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 32% ROE
Firstly, we acknowledge that Applied Materials has a significantly high ROE. Secondly, even when compared to the industry average of 10% the company's ROE is quite impressive. Probably as a result of this, Applied Materials was able to see a decent net income growth of 18% over the last five years.
As a next step, we compared Applied Materials' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 20% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. 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 Making Efficient Use Of Its Profits?
In Applied Materials' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 22% (or a retention ratio of 78%), 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 21%. As a result, Applied Materials' ROE is not expected to change by much either, which we inferred from the analyst estimate of 34% for future ROE.
Overall, we are quite pleased with Applied Materials' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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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