Is Monolithic Power Systems, Inc.'s (NASDAQ:MPWR) Recent Stock Performance Tethered To Its Strong Fundamentals?

Monolithic Power Systems' (NASDAQ:MPWR) stock is up by a considerable 37% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Monolithic Power Systems' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Monolithic Power Systems

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Monolithic Power Systems is:

23% = US$450m ÷ US$1.9b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.23 in profit.

Why Is ROE Important For 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Monolithic Power Systems' Earnings Growth And 23% ROE

To begin with, Monolithic Power Systems has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 15% also doesn't go unnoticed by us. As a result, Monolithic Power Systems' exceptional 36% net income growth seen over the past five years, doesn't come as a surprise.

Next, on comparing Monolithic Power Systems' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 30% over the last few years.

Earnings growth is a huge factor in stock valuation. 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 Monolithic Power Systems''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Monolithic Power Systems Efficiently Re-investing Its Profits?

Monolithic Power Systems' three-year median payout ratio is a pretty moderate 43%, meaning the company retains 57% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Monolithic Power Systems is reinvesting its earnings efficiently.

Besides, Monolithic Power Systems has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 29% over the next three years. As a result, the expected drop in Monolithic Power Systems' payout ratio explains the anticipated rise in the company's future ROE to 30%, over the same period.

Summary

On the whole, we feel that Monolithic Power Systems' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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

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.