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Methode Electronics' (NYSE:MEI) stock is up by a considerable 11% 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. Specifically, we decided to study Methode Electronics' ROE in this article.
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?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Methode Electronics is:
15% = US$131m ÷ US$851m (Based on the trailing twelve months to October 2020).
The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.15 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
A Side By Side comparison of Methode Electronics' Earnings Growth And 15% ROE
To start with, Methode Electronics' ROE looks acceptable. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. Probably as a result of this, Methode Electronics was able to see a decent growth of 7.0% over the last five years.
Next, on comparing with the industry net income growth, we found that Methode Electronics' reported growth was lower than the industry growth of 10% in the same period, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for MEI? You can find out in our latest intrinsic value infographic research report.
Is Methode Electronics Efficiently Re-investing Its Profits?
Methode Electronics has a low three-year median payout ratio of 16%, meaning that the company retains the remaining 84% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Moreover, Methode Electronics 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.
In total, we are pretty happy with Methode Electronics' performance. 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 a good amount of growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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