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Is The Market Rewarding Analog Devices, Inc. (NASDAQ:ADI) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

It is hard to get excited after looking at Analog Devices' (NASDAQ:ADI) recent performance, when its stock has declined 2.8% over the past three months. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Analog Devices' ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Analog Devices

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Analog Devices is:

10% = US$3.6b ÷ US$36b (Based on the trailing twelve months to April 2023).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.10.

What Has ROE Got To Do With Earnings Growth?

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

A Side By Side comparison of Analog Devices' Earnings Growth And 10% ROE

When you first look at it, Analog Devices' ROE doesn't look that attractive. Next, when compared to the average industry ROE of 16%, the company's ROE leaves us feeling even less enthusiastic. However, the moderate 18% net income growth seen by Analog Devices over the past five years is definitely a positive. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Analog Devices' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 32% in the same period, which is a bit concerning.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Analog Devices''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Analog Devices Using Its Retained Earnings Effectively?

Analog Devices has a significant three-year median payout ratio of 75%, meaning that it is left with only 25% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Besides, Analog Devices has been paying dividends for at least ten years or more. 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 36% over the next three years. As a result, the expected drop in Analog Devices' payout ratio explains the anticipated rise in the company's future ROE to 15%, over the same period.

Summary

Overall, we have mixed feelings about Analog Devices. While the company has posted a decent earnings growth, We do feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings at a higher rate of return. 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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