Should Weakness in Silicon Motion Technology Corporation's (NASDAQ:SIMO) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?
Silicon Motion Technology (NASDAQ:SIMO) has had a rough three months with its share price down 6.2%. 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 Silicon Motion Technology's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Silicon Motion Technology
How To 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 Silicon Motion Technology is:
20% = US$141m ÷ US$707m (Based on the trailing twelve months to September 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.20 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
A Side By Side comparison of Silicon Motion Technology's Earnings Growth And 20% ROE
To begin with, Silicon Motion Technology seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 16%. However, we are curious as to how the high returns still resulted in flat growth for Silicon Motion Technology in the past five years. Therefore, there could be some other aspects that could potentially be preventing the company from growing. 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.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Silicon Motion Technology fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Silicon Motion Technology Making Efficient Use Of Its Profits?
The high three-year median payout ratio of 54% (meaning, the company retains only 46% of profits) for Silicon Motion Technology suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.
Moreover, Silicon Motion Technology has been paying dividends for nine 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 17% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
Summary
On the whole, we do feel that Silicon Motion Technology has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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