Is Weakness In Power Integrations, Inc. (NASDAQ:POWI) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?
Power Integrations (NASDAQ:POWI) has had a rough three months with its share price down 19%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Power Integrations' ROE.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Power Integrations
How Is ROE Calculated?
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 Power Integrations is:
26% = US$185m ÷ US$710m (Based on the trailing twelve months to June 2022).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.26 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Power Integrations' Earnings Growth And 26% ROE
To begin with, Power Integrations has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 19% also doesn't go unnoticed by us. Under the circumstances, Power Integrations' considerable five year net income growth of 29% was to be expected.
We then performed a comparison between Power Integrations' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 26% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Power Integrations fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Power Integrations Making Efficient Use Of Its Profits?
Power Integrations has a really low three-year median payout ratio of 21%, meaning that it has the remaining 79% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 21% of its profits over the next three years. Still, forecasts suggest that Power Integrations' future ROE will drop to 20% 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. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.
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