Is Analog Devices, Inc.'s (NASDAQ:ADI) Latest Stock Performance Being Led By Its Strong Fundamentals?

August 05, 2021
  •  Updated
November 28, 2022
NasdaqGS:ADI
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Most readers would already know that Analog Devices' (NASDAQ:ADI) stock increased by 8.1% over the past three months. 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 Analog Devices' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Analog Devices

How Do You 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 Analog Devices is:

13% = US$1.6b ÷ US$12b (Based on the trailing twelve months to May 2021).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.13.

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.

Analog Devices' Earnings Growth And 13% ROE

To begin with, Analog Devices seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 15%. Consequently, this likely laid the ground for the decent growth of 14% seen over the past five years by Analog Devices.

We then performed a comparison between Analog Devices' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 16% in the same period.

past-earnings-growth
NasdaqGS:ADI Past Earnings Growth August 6th 2021

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 ADI fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Analog Devices Using Its Retained Earnings Effectively?

Analog Devices has a significant three-year median payout ratio of 62%, meaning that it is left with only 38% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Besides, Analog Devices has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 44% over the next three years. As a result, the expected drop in Analog Devices' payout ratio explains the anticipated rise in the company's future ROE to 17%, over the same period.

Summary

In total, we are pretty happy with Analog Devices' performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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