Microsoft Corporation's (NASDAQ:MSFT) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?
Microsoft (NASDAQ:MSFT) has had a rough three months with its share price down 14%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Microsoft's 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Microsoft
How Do You Calculate Return On Equity?
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 Microsoft is:
44% = US$72b ÷ US$163b (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 $0.44.
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. 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.
Microsoft's Earnings Growth And 44% ROE
To begin with, Microsoft has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. As a result, Microsoft's exceptional 28% net income growth seen over the past five years, doesn't come as a surprise.
Next, on comparing Microsoft's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 25% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is MSFT worth today? The intrinsic value infographic in our free research report helps visualize whether MSFT is currently mispriced by the market.
Is Microsoft Making Efficient Use Of Its Profits?
The three-year median payout ratio for Microsoft is 33%, which is moderately low. The company is retaining the remaining 67%. So it seems that Microsoft is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.
Besides, Microsoft has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 21% over the next three years. Still forecasts suggest that Microsoft's future ROE will drop to 35% even though the the company's payout ratio is expected to decrease. This suggests that there could be other factors could driving the anticipated decline in the company's ROE.
Summary
On the whole, we feel that Microsoft's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.
