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Silicon Motion Technology Corporation's (NASDAQ:SIMO) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

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Silicon Motion Technology (NASDAQ:SIMO) has had a great run on the share market with its stock up by a significant 5.1% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Silicon Motion Technology'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Silicon Motion Technology

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 Silicon Motion Technology is:

17% = US$104m ÷ US$596m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.17 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Silicon Motion Technology's Earnings Growth And 17% ROE

At first glance, Silicon Motion Technology seems to have a decent ROE. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. Given the circumstances, we can't help but wonder why Silicon Motion Technology saw little to no growth in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Silicon Motion Technology's reported growth was lower than the industry growth of 15% in the same period, which is not something we like to see.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. What is SIMO worth today? The intrinsic value infographic in our free research report helps visualize whether SIMO is currently mispriced by the market.

Is Silicon Motion Technology Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 49% (or a retention ratio of 51%), Silicon Motion Technology hasn't seen much growth in its earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Silicon Motion Technology has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 32% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we feel that Silicon Motion Technology certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.