Most readers would already be aware that Teradyne's (NASDAQ:TER) stock increased significantly by 15% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Teradyne's ROE.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
ROE 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 Teradyne is:
37% = US$840m ÷ US$2.3b (Based on the trailing twelve months to July 2022).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.37 in profit.
Why Is ROE Important For 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.
Teradyne's Earnings Growth And 37% ROE
First thing first, we like that Teradyne has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 19% also doesn't go unnoticed by us. As a result, Teradyne's exceptional 27% net income growth seen over the past five years, doesn't come as a surprise.
We then performed a comparison between Teradyne's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth 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. Doing so will help them establish if the stock's future looks promising or ominous. Is TER fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Teradyne Making Efficient Use Of Its Profits?
Teradyne's three-year median payout ratio to shareholders is 8.3%, which is quite low. This implies that the company is retaining 92% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Moreover, Teradyne is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 8.9%. Accordingly, forecasts suggest that Teradyne's future ROE will be 38% which is again, similar to the current ROE.
On the whole, we feel that Teradyne's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.
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