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Should Weakness in Semtech Corporation's (NASDAQ:SMTC) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

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With its stock down 9.4% over the past three months, it is easy to disregard Semtech (NASDAQ:SMTC). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Semtech's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Semtech

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 Semtech is:

8.6% = US$60m ÷ US$699m (Based on the trailing twelve months to January 2021).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.09 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Semtech's Earnings Growth And 8.6% ROE

On the face of it, Semtech's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 12%. However, the moderate 7.3% net income growth seen by Semtech over the past five years is definitely a positive. 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 compared Semtech's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 14% in the same period, which is a bit concerning.

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. Is Semtech fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Semtech Efficiently Re-investing Its Profits?

Summary

On the whole, we do feel that Semtech has some positive attributes. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. 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 (at) simplywallst.com.