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This article first appeared on Simply Wall St News.
After a parabolic jump in July, Advanced Micro Devices (NASDAQ: AMD) stock had an uneventful rest of the summer, as the stock retraced toward the key psychologic level of U$100.
With the stock making a clean lower high, in addition to the broad market pullback, it would not be surprising to see it overshoot toward the key level at US$95. This sets an opportunity for those waiting for the next opportunity to get in or increase their long positions.
Xilinx’s (NASDAQ: XLNX) acquisition remains in the spotlight amid the Chinese regulatory pressures. The US$35b strategic acquisition is still waiting for approval for China, with the positive initial rumors. The company has already secured antitrust approvals from Europe and the U.S.
Meanwhile, AMD is looking to expand its server CPU market share, as it will deliver its EPYC 7532 and EPYC 7543 processors for the new Polaris supercomputer at the Department of Energy (DOE). Along with AMD’s processors, the supercomputer will use Nvidia’s GPUs.
In addition, Cloudflare is pushing for AMD’s products as well, as they stated that the power consumption was significantly lower compared to Intel’s alternatives. While retail clients might have brand preferences, when it comes to large-scale server operations, power consumption is a significant variable in the overall profitability equation.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. Simply put, it is used to assess a company’s profitability concerning its equity capital.
How To 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 Advanced Micro Devices is:
49% = US$3.4b ÷ US$7.1b (Based on the trailing twelve months to June 2021).
The “return” is the yearly profit.
So, this means that for every $1 of its shareholder’s investments, the company generates a profit of $0.49.
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 can evaluate a company’s future ability to generate profits.
Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the company’s growth rate compared to companies that don’t necessarily bear these characteristics.
Advanced Micro Devices’ Earnings Growth And 49% ROE
First thing first, Advanced Micro Devices has an impressive ROE. Additionally, the company’s ROE is higher than the industry average of 15%, which is remarkable.
As a result, Advanced Micro Devices’ exceptional 81% net income growth was seen over the past five years doesn’t come as a surprise.
We then compared Advanced Micro Devices’ 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 16% in the same period.
Earnings growth is a huge factor in stock valuation. An investor needs 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. If you’re wondering about Advanced Micro Devices”s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
On the whole, we feel that Advanced Micro Devices’ performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This, of course, has caused the company to see substantial growth in its earnings.
Given the exceptional returns, it is also not surprising that the company is not paying a dividend yet, but we can expect that down the road as the expansion slows down and returns move closer to the mean.
Having said that, the company’s earnings growth is expected to slow down, as forecast in the current analyst estimates. To know more about the company’s future earnings growth forecasts, take a look at this free report on analyst forecasts to find out more.
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article 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.