It is hard to get excited after looking at Micron Technology’s (NASDAQ:MU) recent performance, when its stock has declined 12% over the past month. However, the company’s fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Micron Technology’s ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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How Do You 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 Micron Technology is:
17% = US$8.7b ÷ US$50b (Based on the trailing twelve months to September 2022).
The ‘return’ is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder’s investments, the company generates a profit of $0.17.
What Is The Relationship Between ROE And Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Micron Technology’s Earnings Growth And 17% ROE
To start with, Micron Technology’s ROE looks acceptable. Further, the company’s ROE is similar to the industry average of 19%. For this reason, Micron Technology’s five year net income decline of 11% raises the question as to why the decent ROE didn’t translate into growth. So, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
However, when we compared Micron Technology’s growth with the industry we found that while the company’s earnings have been shrinking, the industry has seen an earnings growth of 28% in the same period. This is quite worrisome.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock’s future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Micron Technology is trading on a high P/E or a low P/E, relative to its industry.
Is Micron Technology Using Its Retained Earnings Effectively?
Micron Technology’s low three-year median payout ratio of 3.7% (or a retention ratio of 96%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company’s earnings have actually shrunk. This typically shouldn’t be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company’s business may be deteriorating.
In addition, Micron Technology only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 11% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company’s expected ROE (to 12%) over the same period.
Summary
Overall, we feel that Micron Technology certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that’s preventing growth. Having said that, looking at current analyst estimates, we found that the company’s earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
