Shares of Analog Devices, Inc. (NASDAQ:ADI) soar, but financial results seem inconsistent: will the growth trend continue?

Analog Devices ( NASDAQ:ADI ) has had a great run in the stock market, with its stock up a significant 19% over the last three months. However, the company’s key financial metrics appear to be diverging across the board, which makes us question whether the company’s current share price momentum can be sustained. Especially today, we’ll be paying attention to Analog Devices’ ROE.

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

Check out our latest analysis for analog devices

How to calculate return on equity?

The return on equity formula Is:

Return on equity = Net profit (from continuing operations) ÷ Shareholders’ equity

Therefore, based on the above formula, ROE for analog devices is:

6.1% = USD 2.1 billion ÷ USD 35 billion (Based on the trailing twelve months to May 2024).

The “return” is the profit over the last twelve months. Another way to think about it is that for every $1 of equity, the company was able to earn $0.06 in profit.

What does ROE have to do with profit growth?

We have already established that ROE serves as an effective profit-generating measure for a company’s future earnings. Depending on how much of these profits the company reinvests or “retains” and how effectively it does so, we are able to assess the company’s earnings growth potential. Generally speaking, all things being equal, companies that have a high return on equity and profit retention have a higher growth rate than companies that do not have these characteristics.

Analog Devices earnings growth and 6.1% ROE

At first glance, Analog Devices’ ROE doesn’t have much to say. A quick further examination shows that the company’s ROE also does not compare favorably to the industry average of 15%. However, we’re pleasantly surprised to see that Analog Devices has grown its net income at a significant rate of 22% over the last five years. We believe other factors may be at play. For example, the company has a low payout ratio or is run efficiently.

We next compared Analog Devices’ net income growth to the industry and were disappointed to see that the company’s growth was lower than the industry average growth of 31% over the same period.

The basis for assigning value to a company is largely the growth of its profits. It is important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). This will let them know whether the herd is heading to clear blue waters or whether swampy waters await there. Has the market priced in ADI’s future prospects? You can find out in our latest Intrinsic Value Infographic Research Report.

The story continues

Do analog devices use their profits effectively?

The high three-year median payout of 60% (meaning the company retains only 40% of profits) for Analog Devices suggests that the company’s growth has not been significantly hampered, even though it has returned most of its profits to its shareholders.

Additionally, Analog Devices has been paying dividends for at least ten years, which means the company is quite serious about sharing profits with shareholders. Our latest analytical data shows that the company’s future payout rate will drop to 42% over the next three years. Therefore, the expected decline in the payout ratio explains the expected increase in the company’s ROE to 16% over the same period.

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Overall, we have mixed feelings about Analog Devices. While the company has seen decent earnings growth, we believe that earnings growth could have been even higher if the company had reinvested more of its earnings at a higher rate of return. We have also analyzed the latest analyst forecasts and found that the company is expected to see earnings growth similar to its current growth rate. Are these analyst expectations based on broad industry expectations or on the company’s fundamentals? Click here to visit our analyst forecasts for the company.

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This article by Simply Wall St is of a general nature. We comment based on historical data and analyst forecasts, using only an unbiased methodology, and our articles are not intended to provide financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide long-term, focused analysis based on fundamental data. Please note that our analysis may not reflect the latest price-sensitive company announcements or qualitative content. Simply Wall St has no position in any of the stocks mentioned.

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