Declining Stock and Solid Fundamentals: Is The Market Wrong About Richardson Electronics, Ltd. (NASDAQ:RELL)?
With its stock down 14% over the past month, it is easy to disregard Richardson Electronics (NASDAQ:RELL). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Richardson Electronics' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for Richardson Electronics
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Richardson Electronics is:
17% = US$26m ÷ US$155m (Based on the trailing twelve months to February 2023).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.17.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Richardson Electronics' Earnings Growth And 17% ROE
To start with, Richardson Electronics' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 12%. Probably as a result of this, Richardson Electronics was able to see an impressive net income growth of 63% over the last five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing with the industry net income growth, we found that Richardson Electronics' growth is quite high when compared to the industry average growth of 16% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Richardson Electronics is trading on a high P/E or a low P/E, relative to its industry.
Is Richardson Electronics Using Its Retained Earnings Effectively?
Richardson Electronics has a really low three-year median payout ratio of 14%, meaning that it has the remaining 86% left over to reinvest into its business. So it looks like Richardson Electronics is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Additionally, Richardson Electronics 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.
Conclusion
On the whole, we feel that Richardson Electronics' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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