Is Weakness In Cadence Design Systems, Inc. (NASDAQ:CDNS) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

It is hard to get excited after looking at Cadence Design Systems' (NASDAQ:CDNS) recent performance, when its stock has declined 2.4% over the past week. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Cadence Design Systems' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Cadence Design Systems

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Cadence Design Systems is:

31% = US$890m ÷ US$2.9b (Based on the trailing twelve months to June 2023).

The 'return' is the profit 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 $0.31 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Cadence Design Systems' Earnings Growth And 31% ROE

To begin with, Cadence Design Systems has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 9.8% also doesn't go unnoticed by us. This likely paved the way for the modest 15% net income growth seen by Cadence Design Systems over the past five years.

We then compared Cadence Design Systems' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 19% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. 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 Cadence Design Systems''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Cadence Design Systems Efficiently Re-investing Its Profits?

Cadence Design Systems doesn't pay any dividend, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.

Summary

Overall, we are quite pleased with Cadence Design Systems' performance. 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 a good amount of growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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. 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.