Are Strong Financial Prospects The Force That Is Driving The Momentum In Applied Materials, Inc.'s NASDAQ:AMAT) Stock?

Most readers would already be aware that Applied Materials' (NASDAQ:AMAT) stock increased significantly by 31% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Applied Materials' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Applied Materials

How Is ROE Calculated?

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 Applied Materials is:

46% = US$6.5b ÷ US$14b (Based on the trailing twelve months to April 2023).

The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.46 in profit.

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. 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.

Applied Materials' Earnings Growth And 46% ROE

Firstly, we acknowledge that Applied Materials has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 16% which is quite remarkable. As a result, Applied Materials' exceptional 20% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Applied Materials' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 32% in the same 5-year period, which is a bit concerning.

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 Applied Materials''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Applied Materials Using Its Retained Earnings Effectively?

Applied Materials' three-year median payout ratio to shareholders is 14%, which is quite low. This implies that the company is retaining 86% of its profits. So it looks like Applied Materials is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, Applied Materials 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 14% 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 45%.

Summary

On the whole, we feel that Applied Materials' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.