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Monolithic Power Systems, Inc.'s (NASDAQ:MPWR) Stock Is Going Strong: Is the Market Following Fundamentals?

Monolithic Power Systems (NASDAQ:MPWR) has had a great run on the share market with its stock up by a significant 26% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Monolithic Power Systems' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Monolithic Power Systems

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

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So, based on the above formula, the ROE for Monolithic Power Systems is:

19% = US$410m ÷ US$2.1b (Based on the trailing twelve months to March 2024).

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 $0.19.

What Is The Relationship Between ROE And 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 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.

A Side By Side comparison of Monolithic Power Systems' Earnings Growth And 19% ROE

To start with, Monolithic Power Systems' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 15%. This certainly adds some context to Monolithic Power Systems' exceptional 33% net income growth seen over the past five years. However, there could also be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then performed a comparison between Monolithic Power Systems' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 31% in the same 5-year period.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Monolithic Power Systems fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Monolithic Power Systems Using Its Retained Earnings Effectively?

Monolithic Power Systems has a three-year median payout ratio of 43% (where it is retaining 57% of its income) which is not too low or not too high. So it seems that Monolithic Power Systems is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, Monolithic Power Systems has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 26% over the next three years. The fact that the company's ROE is expected to rise to 29% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, we feel that Monolithic Power Systems' 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 substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com