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Is Power Integrations, Inc.'s (NASDAQ:POWI) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Simply Wall St

Power Integrations''s (NASDAQ:POWI) stock is up by a considerable 12% over the past month. 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 Power Integrations' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Power Integrations

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 Power Integrations is:

27% = US$202m ÷ US$744m (Based on the trailing twelve months to March 2020).

The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.27.

Why Is ROE Important For 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.

Power Integrations' Earnings Growth And 27% ROE

Firstly, we acknowledge that Power Integrations has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. As a result, Power Integrations' exceptional 26% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Power Integrations' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 21% in the same period.

NasdaqGS:POWI Past Earnings Growth May 8th 2020

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Power Integrations''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Power Integrations Making Efficient Use Of Its Profits?

The three-year median payout ratio for Power Integrations is 30%, which is moderately low. The company is retaining the remaining 70%. So it seems that Power Integrations is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Additionally, Power Integrations 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 24%. Still, forecasts suggest that Power Integrations' future ROE will drop to 13% even though the the company's payout ratio is not expected to change by much.

Conclusion

Overall, we are quite pleased with Power Integrations' 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 substantial growth in its earnings. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.