NVE Corporation's (NASDAQ:NVEC) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

NVE's (NASDAQ:NVEC) stock is up by a considerable 39% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to NVE's 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for NVE

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 NVE is:

16% = US$12m ÷ US$73m (Based on the trailing twelve months to December 2020).

The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.16 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. 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 NVE's Earnings Growth And 16% ROE

To start with, NVE's ROE looks acceptable. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. Given the circumstances, we can't help but wonder why NVE saw little to no growth in the past five years. Therefore, there could be some other aspects that could potentially be preventing the company from growing. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, on comparing with the industry net income growth, we found that NVE's reported growth was lower than the industry growth of 14% in the same period, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if NVE is trading on a high P/E or a low P/E, relative to its industry.

Is NVE Efficiently Re-investing Its Profits?

NVE has a three-year median payout ratio as high as 138% meaning that the company is paying a dividend which is beyond its means. The absence of growth in NVE's earnings therefore, doesn't come as a surprise. Paying a dividend higher than reported profits is not a sustainable move. This is indicative of risk. You can see the 2 risks we have identified for NVE by visiting our risks dashboard for free on our platform here.

Additionally, NVE has paid dividends over a period of six years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

In total, we're a bit ambivalent about NVE's performance. In spite of the high ROE, the company has failed to see growth in its earnings due to it paying out most of its profits as dividend, with almost nothing left to invest into its own business. So far, we've only made a quick discussion around the company's earnings growth. You can do your own research on NVE and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.

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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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