With its stock down 36% over the past three months, it is easy to disregard NVIDIA (NASDAQ:NVDA). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study NVIDIA’s ROE in this article.
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.
See our latest analysis for NVIDIA
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for NVIDIA is:
37% = US$9.8b ÷ US$27b (Based on the trailing twelve months to January 2022).
The ‘return’ is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.37 in profit.
Why Is ROE Important For Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
NVIDIA’s Earnings Growth And 37% ROE
Firstly, we acknowledge that NVIDIA has a significantly high ROE. Secondly, even when compared to the industry average of 19% the company’s ROE is quite impressive. So, the substantial 25% net income growth seen by NVIDIA over the past five years isn’t overly surprising.
Next, on comparing NVIDIA’s net income growth with the industry, we found that the company’s reported growth is similar to the industry average growth rate of 23% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock’s future looks promising or ominous. What is NVDA worth today? The intrinsic value infographic in our free research report helps visualize whether NVDA is currently mispriced by the market.
Is NVIDIA Using Its Retained Earnings Effectively?
NVIDIA’s three-year median payout ratio to shareholders is 11%, which is quite low. This implies that the company is retaining 89% of its profits. So it looks like NVIDIA is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Additionally, NVIDIA has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 2.3% over the next three years. The fact that the company’s ROE is expected to rise to 47% over the same period is explained by the drop in the payout ratio.
Summary
Overall, we are quite pleased 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 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
