Should Weakness in Analog Devices, Inc.'s (NASDAQ:ADI) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?
Analog Devices (NASDAQ:ADI) has had a rough week with its share price down 3.5%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Analog Devices' 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Analog Devices
How Do You 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 Analog Devices is:
7.9% = US$2.8b ÷ US$36b (Based on the trailing twelve months to February 2024).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.08 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned 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. 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 Analog Devices' Earnings Growth And 7.9% ROE
At first glance, Analog Devices' ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 14% either. In spite of this, Analog Devices was able to grow its net income considerably, at a rate of 23% in the last five years. So, there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then performed a comparison between Analog Devices' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 29% in the same 5-year period.
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. Is ADI fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Analog Devices Making Efficient Use Of Its Profits?
Analog Devices has a significant three-year median payout ratio of 60%, meaning the company only retains 40% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.
Additionally, Analog Devices 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 45% over the next three years. As a result, the expected drop in Analog Devices' payout ratio explains the anticipated rise in the company's future ROE to 14%, over the same period.
Conclusion
Overall, we feel that Analog Devices certainly does have some positive factors to consider. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.
