It is hard to get excited after looking at Teradyne's (NASDAQ:TER) recent performance, when its stock has declined 15% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Teradyne's ROE today.
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.
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:
21% = US$504m ÷ US$2.4b (Based on the trailing twelve months to October 2023).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.21.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Teradyne's Earnings Growth And 21% ROE
To start with, Teradyne's ROE looks acceptable. On comparing with the average industry ROE of 15% the company's ROE looks pretty remarkable. Probably as a result of this, Teradyne was able to see a decent growth of 11% over the last five years.
As a next step, we compared Teradyne'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 30% in the same period.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for TER? You can find out in our latest intrinsic value infographic research report.
Is Teradyne Using Its Retained Earnings Effectively?
Teradyne has a low three-year median payout ratio of 8.3%, meaning that the company retains the remaining 92% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Besides, Teradyne has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. 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 8.3%. Still, forecasts suggest that Teradyne's future ROE will rise to 32% even though the the company's payout ratio is not expected to change by much.
On the whole, we feel that Teradyne's performance has been quite good. 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
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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.