With its stock down 15% over the past month, it is easy to disregard Teradyne (NASDAQ:TER). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Teradyne's ROE.
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.
How Is ROE Calculated?
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 Teradyne is:
36% = US$626m ÷ US$1.7b (Based on the trailing twelve months to June 2020).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.36 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. 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.
Teradyne's Earnings Growth And 36% ROE
First thing first, we like that Teradyne has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 11% also doesn't go unnoticed by us. Under the circumstances, Teradyne's considerable five year net income growth of 38% was to be expected.
As a next step, we compared Teradyne's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 16%.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. What is TER worth today? The intrinsic value infographic in our free research report helps visualize whether TER is currently mispriced by the market.
Is Teradyne Efficiently Re-investing Its Profits?
Teradyne's ' three-year median payout ratio is on the lower side at 14% implying that it is retaining a higher percentage (86%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Additionally, Teradyne has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 11% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 29%.
Overall, we are quite pleased with Teradyne's performance. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
This article by Simply Wall St is general in nature. 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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