Teradyne (NASDAQ:TER) has had a rough three months with its share price down 10%. 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 Teradyne's 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Teradyne

How To Calculate Return On Equity?

ROE 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 profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.21.

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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

A Side By Side comparison of Teradyne's Earnings Growth And 21% ROE

At first glance, Teradyne seems to have a decent ROE. Especially when compared to the industry average of 15% the company's ROE looks pretty impressive. Probably as a result of this, Teradyne was able to see a decent growth of 11% over the last five years.

We then compared Teradyne's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 30% in the same 5-year period, which is a bit concerning.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is TER fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Teradyne Efficiently Re-investing Its Profits?

In Teradyne's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 8.3% (or a retention ratio of 92%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Teradyne is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. 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.

Conclusion

In total, we are pretty happy with Teradyne'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 a good amount of growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.