With its share price down 17% over the past three months, it's easy to ignore Microchip Technology Co. (NASDAQ:MCHP). However, a closer look at its healthy financials might give you reason to reconsider. Given that fundamentals usually drive long-term market outcomes, the company is worth keeping an eye on. In particular, we'll be looking at Microchip Technology's ROE today.
Return on equity (ROE) is a key indicator used to assess how efficiently a company's management is utilizing their capital. In other words, it indicates how successful a company is in converting shareholder investments into profits.
View our latest analysis for Microchip Technology
How to Calculate Return on Equity?
Return on equity can be calculated using the following formula:
Return on Equity = Net Income (from continuing operations) / Shareholders' Equity
So, based on the above formula, Microchip Technology's ROE is:
21% = US$1.4b / US$6.4b (Based on the trailing 12 months to June 2024).
“Return” refers to a company's earnings over the past year, meaning that for every $1 of shareholders' capital, the company generated $0.21 in profit.
What is the relationship between ROE and earnings growth?
Thus far, we have learned that ROE is a measure of how efficiently a company is generating its profits. Next, we need to evaluate how much of its profits the company is reinvesting or “retaining” for future growth. This gives us an idea about a company's growth potential. Assuming all other things are equal, companies with both a higher return on equity and retained profits are usually companies with higher growth rates compared to companies that don't share the same characteristics.
Microchip Technology's Revenue Growth and 21% ROE
First, Microchip Technology's ROE looks reasonable. Moreover, the company's ROE compares favorably with the industry average of 13%. This certainly provides some context to Microchip Technology's exceptional net income growth rate of 36% over the past five years. We believe there may also be other factors at play here, such as high profit retention and efficient management.
As a next step, we compared Microchip Technology's net income growth with the industry and found, to our delight, that the company's growth is above the industry average of 28%.
Past Revenue Growth
The criterion for valuing a company is heavily tied to its earnings growth. What investors need to determine next is whether the expected earnings growth, or lack thereof, is already priced into the share price. Doing so will help them gauge whether the stock's future is promising or ominous. Is MCHP fairly valued? This infographic on the company's intrinsic value will tell you all you need to know.
The story continues
Is Microchip Technology reinvesting its profits efficiently?
Microchip Technology's three-year median dividend payout ratio is 37%, which is somewhat low, and the company retains the remaining 63%, meaning that Microchip Technology appears to be reinvesting efficiently in a way that allows for impressive earnings growth (discussed above) and a well-covered dividend payment.
Additionally, Microchip Technology has been paying dividends for at least 10 years, which indicates the company is committed to sharing profits with shareholders. Our most recent analyst data suggests that the company's future dividend payout ratio is expected to rise to 45% over the next three years. However, Microchip Technology's future ROE is expected to rise to 33%, despite the expected increase in the company's dividend payout ratio. We speculate that there are other factors driving the expected growth in the company's ROE.
summary
Overall, we are very pleased with Microchip Technology's performance. We particularly like that the company is reinvesting heavily in its business, resulting in strong rates of return. Not surprisingly, this has led to impressive earnings growth. That said, the company's earnings growth is expected to slow, in line with analysts currently expecting it to. If you want to know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts.
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This article by Simply Wall St is of general nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology, and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks, and does not take into account your objectives or financial situation. We aim to provide long-term analysis driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned herein.
