NVIDIA’s (NASDAQ:NVDA) stock is up by a considerable 27% over the past three months. Given the company’s impressive performance, we decided to study its financial indicators more closely as a company’s financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to NVIDIA’s ROE today.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To Calculate Return On Equity?
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 NVIDIA is:
28% = US$6.0b ÷ US$21b (Based on the trailing twelve months to October 2022).
The ‘return’ is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.28 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don’t have the same features.
NVIDIA’s Earnings Growth And 28% ROE
First thing first, we like that NVIDIA has an impressive ROE. Additionally, the company’s ROE is higher compared to the industry average of 19% which is quite remarkable. Under the circumstances, NVIDIA’s considerable five year net income growth of 23% was to be expected.
As a next step, we compared NVIDIA’s net income growth with the industry and were disappointed to see that the company’s growth is lower than the industry average growth of 29% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). Doing so will help them establish if the stock’s future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if NVIDIA is trading on a high P/E or a low P/E, relative to its industry.
Is NVIDIA Making Efficient Use Of Its Profits?
NVIDIA has a really low three-year median payout ratio of 7.1%, meaning that it has the remaining 93% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Besides, NVIDIA has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company’s future payout ratio is expected to drop to 2.6% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company’s ROE to 53%, over the same period.
In total, we are pretty happy with NVIDIA’s performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
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