Is Monolithic Power Systems, Inc.'s (NASDAQ:MPWR) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Monolithic Power Systems (NASDAQ:MPWR) has had a great run on the share market with its stock up by a significant 13% over the last week. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Monolithic Power Systems' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Monolithic Power Systems

How Is ROE Calculated?

The formula for return on equity is:

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

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

21% = US$427m ÷ US$2.0b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.21 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Monolithic Power Systems' Earnings Growth And 21% ROE

At first glance, Monolithic Power Systems seems to have a decent ROE. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. This certainly adds some context to Monolithic Power Systems' exceptional 34% net income growth seen over the past five years. We believe that there might also 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 Monolithic Power Systems' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 30% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Using Its Retained Earnings Effectively?

Monolithic Power Systems' three-year median payout ratio is a pretty moderate 43%, meaning the company retains 57% of its income. So it seems that Monolithic Power Systems is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, Monolithic Power Systems has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 30% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 29%, over the same period.

Conclusion

In total, we are pretty happy with Monolithic Power Systems' 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. 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.

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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.