Most readers would already be aware that Silicon Motion Technology's (NASDAQ:SIMO) stock increased significantly by 11% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Silicon Motion Technology'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Is ROE Calculated?

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 Silicon Motion Technology is:

7.8% = US$59m ÷ US$753m (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.08 in profit.

What Has ROE Got To Do With 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 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.

Silicon Motion Technology's Earnings Growth And 7.8% ROE

At first glance, Silicon Motion Technology's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 15% either. However, the moderate 7.3% net income growth seen by Silicon Motion Technology over the past five years is definitely a positive. So, the growth in the company's earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Silicon Motion Technology's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 31% in the same period.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Silicon Motion Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Silicon Motion Technology Using Its Retained Earnings Effectively?

Silicon Motion Technology has a healthy combination of a moderate three-year median payout ratio of 29% (or a retention ratio of 71%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Silicon Motion Technology has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 34% of its profits over the next three years. However, Silicon Motion Technology's ROE is predicted to rise to 20% despite there being no anticipated change in its payout ratio.

Summary

In total, it does look like Silicon Motion Technology has some positive aspects to its business. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

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