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Declining Stock and Solid Fundamentals: Is The Market Wrong About Power Integrations, Inc. (NASDAQ:POWI)?

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With its stock down 7.2% over the past three months, it is easy to disregard Power Integrations (NASDAQ:POWI). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Power Integrations' ROE in this article.

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 Power Integrations

How To Calculate Return On Equity?

Return on equity 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 Power Integrations is:

21% = US$171m ÷ US$821m (Based on the trailing twelve months to March 2022).

The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.21.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Power Integrations' Earnings Growth And 21% ROE

At first glance, Power Integrations seems to have a decent ROE. Even when compared to the industry average of 19% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 29% seen over the past five years by Power Integrations. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared Power Integrations' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 23% in the same period.

past-earnings-growth
past-earnings-growth

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 Power Integrations fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Power Integrations Making Efficient Use Of Its Profits?

Power Integrations' ' three-year median payout ratio is on the lower side at 21% implying that it is retaining a higher percentage (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.

Moreover, Power Integrations 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 18%. Accordingly, forecasts suggest that Power Integrations' future ROE will be 23% which is again, similar to the current ROE.

Summary

On the whole, we feel that Power Integrations' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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