It is hard to get excited after looking at Cadence Design Systems' (NASDAQ:CDNS) recent performance, when its stock has declined 12% over the past month. 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. Particularly, we will be paying attention to Cadence Design Systems' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Cadence Design Systems

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 Cadence Design Systems is:

30% = US$775m ÷ US$2.6b (Based on the trailing twelve months to July 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 $0.30 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Cadence Design Systems' Earnings Growth And 30% ROE

First thing first, we like that Cadence Design Systems has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. As a result, Cadence Design Systems' exceptional 24% net income growth seen over the past five years, doesn't come as a surprise.

As a next step, we compared Cadence Design Systems' 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 25% in the same period.

Earnings growth is a huge factor in stock valuation. 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. What is CDNS worth today? The intrinsic value infographic in our free research report helps visualize whether CDNS is currently mispriced by the market.

Is Cadence Design Systems Making Efficient Use Of Its Profits?

Cadence Design Systems doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Summary

Overall, we are quite pleased with Cadence Design Systems' 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.