Stock Analysis

Is Analog Devices, Inc.'s (NASDAQ:ADI) Recent Price Movement Underpinned By Its Weak Fundamentals?

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NasdaqGS:ADI
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It is hard to get excited after looking at Analog Devices' (NASDAQ:ADI) recent performance, when its stock has declined 11% over the past month. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Analog Devices

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 Analog Devices is:

5.2% = US$1.9b ÷ US$37b (Based on the trailing twelve months to July 2022).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.05 in profit.

What Has ROE Got To Do With 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Analog Devices' Earnings Growth And 5.2% ROE

On the face of it, Analog Devices' 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 19%. Although, we can see that Analog Devices saw a modest net income growth of 9.8% over the past five years. 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.

As a next step, we compared Analog Devices' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 26% in the same period.

past-earnings-growth
NasdaqGS:ADI Past Earnings Growth September 26th 2022

Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for ADI? You can find out in our latest intrinsic value infographic research report.

Is Analog Devices Efficiently Re-investing Its Profits?

While Analog Devices has a three-year median payout ratio of 75% (which means it retains 25% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Additionally, Analog Devices has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 37% 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 14%, over the same period.

Conclusion

In total, we're a bit ambivalent about Analog Devices' performance. While no doubt its earnings growth is pretty respectable, the low profit retention could mean that the company's earnings growth could have been higher, had it been paying reinvesting a higher portion of its profits. An improvement in its ROE could also help future earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

Valuation is complex, but we're helping make it simple.

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About NasdaqGS:ADI

Analog Devices

Analog Devices, Inc. designs, manufactures, tests, and markets integrated circuits (ICs), software, and subsystems that leverage analog, mixed-signal, and digital signal processing technologies.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation1
Future Growth1
Past Performance5
Financial Health5
Dividends5

Read more about these checks in the individual report sections or in our analysis model.

Solid track record with excellent balance sheet and pays a dividend.