Microsoft Down 8.3% Despite Solid Earnings Growth

Microsoft (NASDAQ:MSFT) has had a rough month with its share price down 8.3%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Microsoft's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Microsoft

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 Microsoft is:

40% = US$70b ÷ US$174b (Based on the trailing twelve months to September 2022).

The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.40.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Microsoft's Earnings Growth And 40% ROE

First thing first, we like that Microsoft has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 12% also doesn't go unnoticed by us. As a result, Microsoft's exceptional 27% net income growth seen over the past five years, doesn't come as a surprise.

As a next step, we compared Microsoft's 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 24% in the same period.

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. Is MSFT fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Microsoft Making Efficient Use Of Its Profits?

Microsoft has a three-year median payout ratio of 30% (where it is retaining 70% of its income) which is not too low or not too high. So it seems that Microsoft is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, Microsoft is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 24% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

On the whole, we feel that Microsoft's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.