Yahoo Finance Arista Networks, Inc.'s (NYSE:ANET) Stock's On An Uptrend: Are Strong Financials Guiding The Market?
Arista Networks' (NYSE:ANET) stock is up by a considerable 23% over the past month. 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 Arista Networks' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Arista Networks
How Is ROE Calculated?
ROE 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 Arista Networks is:
28% = US$797m ÷ US$2.8b (Based on the trailing twelve months to March 2020).
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 $0.28.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Arista Networks' Earnings Growth And 28% ROE
First thing first, we like that Arista Networks has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 5.2% also doesn't go unnoticed by us. So, the substantial 41% net income growth seen by Arista Networks over the past five years isn't overly surprising.
Next, on comparing with the industry net income growth, we found that Arista Networks' growth is quite high when compared to the industry average growth of 5.0% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Arista Networks is trading on a high P/E or a low P/E, relative to its industry.
Is Arista Networks Making Efficient Use Of Its Profits?
Arista Networks doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.
Conclusion
On the whole, we feel that Arista Networks' 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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
This article by Simply Wall St is general in nature. 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.
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