Are Robust Financials Driving The Recent Rally In Palo Alto Networks, Inc.'s (NASDAQ:PANW) Stock?

Palo Alto Networks' (NASDAQ:PANW) stock is up by a considerable 7.9% over the past week. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Palo Alto Networks' ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Palo Alto Networks

How To Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for Palo Alto Networks is:

55% = US$2.4b ÷ US$4.5b (Based on the trailing twelve months to April 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.55.

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. 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 Palo Alto Networks' Earnings Growth And 55% ROE

Firstly, we acknowledge that Palo Alto Networks has a significantly high ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. So, the substantial 65% net income growth seen by Palo Alto Networks over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Palo Alto Networks' growth is quite high when compared to the industry average growth of 15% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is PANW fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Palo Alto Networks Efficiently Re-investing Its Profits?

Palo Alto Networks doesn't pay any regular dividends currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Conclusion

In total, we are pretty happy with Palo Alto Networks' performance. 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, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.