Power Integrations (NASDAQ:POWI) has had a rough month with its share price down 15%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Power Integrations' 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 Power Integrations

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 Power Integrations is:

26% = US$185m ÷ US$710m (Based on the trailing twelve months to June 2022).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.26.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Power Integrations' Earnings Growth And 26% ROE

Firstly, we acknowledge that Power Integrations 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 29% net income growth seen by Power Integrations over the past five years isn't overly surprising.

As a next step, we compared Power Integrations' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 26% 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. 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 Power Integrations is trading on a high P/E or a low P/E, relative to its industry.

Is Power Integrations Making Efficient Use Of Its Profits?

Power Integrations' three-year median payout ratio to shareholders is 21%, which is quite low. This implies that the company is retaining 79% 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.

Besides, Power Integrations has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 20% 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 22%.

Conclusion

On the whole, we feel that Power Integrations' performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.