Are Strong Financial Prospects The Force That Is Driving The Momentum In Renesas Electronics Corporation's TSE:6723) Stock?

Most readers would already be aware that Renesas Electronics' (TSE:6723) stock increased significantly by 6.0% over the past week. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Renesas Electronics' ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Renesas Electronics

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 Renesas Electronics is:

17% = JP¥337b ÷ JP¥2.0t (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. That means that for every ¥1 worth of shareholders' equity, the company generated ¥0.17 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Renesas Electronics' Earnings Growth And 17% ROE

To begin with, Renesas Electronics seems to have a respectable ROE. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Probably as a result of this, Renesas Electronics was able to see an impressive net income growth of 59% over the last five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared Renesas Electronics' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 26% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is 6723 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Renesas Electronics Making Efficient Use Of Its Profits?

Renesas Electronics' ' three-year median payout ratio is on the lower side at 15% implying that it is retaining a higher percentage (85%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 13% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 17%.

Summary

Overall, we are quite pleased with Renesas Electronics' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.