Garmin's (NASDAQ:GRMN) stock is up by a considerable 24% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Garmin's ROE today.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
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 Garmin is:
20% = US$934m ÷ US$4.7b (Based on the trailing twelve months to June 2020).
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 $0.20 in profit.
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. 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. 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 Garmin's Earnings Growth And 20% ROE
To start with, Garmin's ROE looks acceptable. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. Probably as a result of this, Garmin was able to see a decent growth of 16% over the last five years.
As a next step, we compared Garmin's 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 18% in the same period.
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). Doing so will help them establish if the stock's future looks promising or ominous. Is Garmin fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Garmin Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 57% (or a retention ratio of 43%) for Garmin suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Moreover, Garmin is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 54%. As a result, Garmin's ROE is not expected to change by much either, which we inferred from the analyst estimate of 17% for future ROE.
On the whole, we feel that Garmin's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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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