Microchip Technology Incorporated's (NASDAQ:MCHP) Recent Stock Performance Looks Decent- Can Strong Fundamentals Be the Reason?

Microchip Technology's (NASDAQ:MCHP) stock is up by 4.7% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Microchip 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Microchip Technology

How Is ROE Calculated?

ROE 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 Microchip Technology is:

29% = US$1.9b ÷ US$6.7b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.29 in profit.

What Is The Relationship Between ROE And 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. 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 Microchip Technology's Earnings Growth And 29% ROE

Firstly, we acknowledge that Microchip Technology has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 15% also doesn't go unnoticed by us. As a result, Microchip Technology's exceptional 40% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Microchip Technology's 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 31% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Microchip Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Microchip Technology Using Its Retained Earnings Effectively?

The three-year median payout ratio for Microchip Technology is 37%, which is moderately low. The company is retaining the remaining 63%. By the looks of it, the dividend is well covered and Microchip Technology is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Moreover, Microchip Technology is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 42%. Regardless, the future ROE for Microchip Technology is predicted to rise to 49% despite there being not much change expected in its payout ratio.

Conclusion

In total, we are pretty happy with Microchip Technology's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com