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Are Strong Financial Prospects The Force That Is Driving The Momentum In Synopsys, Inc.'s NASDAQ:SNPS) Stock?

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Most readers would already be aware that Synopsys' (NASDAQ:SNPS) stock increased significantly by 21% 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 Synopsys' ROE today.

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 Synopsys

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 Synopsys is:

16% = US$806m ÷ US$5.1b (Based on the trailing twelve months to April 2021).

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 $0.16 in profit.

What Is The Relationship Between ROE And 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. 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.

Synopsys' Earnings Growth And 16% ROE

To begin with, Synopsys seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. This probably goes some way in explaining Synopsys' significant 29% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Synopsys' 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 25% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is SNPS worth today? The intrinsic value infographic in our free research report helps visualize whether SNPS is currently mispriced by the market.

Is Synopsys Using Its Retained Earnings Effectively?

Summary

On the whole, we feel that Synopsys' performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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