Monolithic Power Systems, Inc.'s (NASDAQ:MPWR) Stock Is Going Strong: Is the Market Following Fundamentals?

Monolithic Power Systems' (NASDAQ:MPWR) stock is up by a considerable 16% 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. Particularly, we will be paying attention to Monolithic Power Systems' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Monolithic Power Systems

How Do You Calculate Return On Equity?

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:

17% = US$164m ÷ US$967m (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.17.

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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Monolithic Power Systems' Earnings Growth And 17% ROE

To start with, Monolithic Power Systems' ROE looks acceptable. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. This certainly adds some context to Monolithic Power Systems' exceptional 27% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Monolithic Power Systems' growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.

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. Doing so will help them establish if the stock's future looks promising or ominous. 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?

The high three-year median payout ratio of 55% (implying that it keeps only 45% of profits) for Monolithic Power Systems suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Besides, Monolithic Power Systems has been paying dividends over a period of seven 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 37% 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 26%, over the same period.

Summary

In total, we are pretty happy with Monolithic Power Systems' performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St is general in nature. 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.
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