Most readers would already be aware that Monolithic Power Systems' (NASDAQ:MPWR) stock increased significantly by 10% over the past 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. In this article, we decided to focus on Monolithic Power Systems' ROE.

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.

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 Monolithic Power Systems is:

21% = US$427m ÷ US$2.0b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.21 in profit.

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. 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 Monolithic Power Systems' Earnings Growth And 21% ROE

To begin with, Monolithic Power Systems seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 14%. This probably laid the ground for Monolithic Power Systems' significant 34% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Monolithic Power 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 29% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Monolithic Power Systems''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Monolithic Power Systems Efficiently Re-investing Its Profits?

Monolithic Power Systems' three-year median payout ratio is a pretty moderate 43%, meaning the company retains 57% of its income. By the looks of it, the dividend is well covered and Monolithic Power Systems is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Monolithic Power Systems 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 30% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 29%, over the same period.

Conclusion

Overall, we are quite pleased with Monolithic Power 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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.

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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.