Is the Market Following Fundamentals?

ASML Holding’s (AMS:ASML) stock is up by a considerable 40% over the past three months. 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 ASML Holding’s ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for ASML Holding

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity

So, based on the above formula, the ROE for ASML Holding is:

58% = €7.8b ÷ €13b (Based on the trailing twelve months to December 2023).

The ‘return’ refers to a company’s earnings over the last year. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.58 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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. 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.

ASML Holding’s Earnings Growth And 58% ROE

First thing first, we like that ASML Holding has an impressive ROE. Secondly, even when compared to the industry average of 15% the company’s ROE is quite impressive. So, the substantial 26% net income growth seen by ASML Holding over the past five years isn’t overly surprising.

As a next step, we compared ASML Holding’s net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 31% in the same period.

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. Doing so will help them establish if the stock’s future looks promising or ominous. If you’re wondering about ASML Holding’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is ASML Holding Making Efficient Use Of Its Profits?

ASML Holding has a three-year median payout ratio of 34% (where it is retaining 66% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and ASML Holding is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Story continues

Besides, ASML Holding 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 over the next three years is expected to be approximately 29%. Accordingly, forecasts suggest that ASML Holding’s future ROE will be 56% which is again, similar to the current ROE.

Summary

On the whole, we feel that ASML Holding’s 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. Having said that, the company’s earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company’s fundamentals? Click here to be taken to our analyst’s forecasts page 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.