Does The Market Have A Low Tolerance For Novanta Inc.'s (NASDAQ:NOVT) Mixed Fundamentals?

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It is hard to get excited after looking at Novanta’s (NASDAQ:NOVT) recent performance, when its stock has declined 8.1% over the past month. It seems that the market might have completely ignored the positive aspects of the company’s fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company’s financial performance. In this article, we decided to focus on Novanta’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. Put another way, it reveals the company’s success at turning shareholder investments into profits.

See our latest analysis for Novanta

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 Novanta is:

9.7% = US$50m ÷ US$521m (Based on the trailing twelve months to December 2021).

The ‘return’ is the yearly profit. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.10 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Novanta’s Earnings Growth And 9.7% ROE

On the face of it, Novanta’s ROE is not much to talk about. We then compared the company’s ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 13%. As a result, Novanta reported a very low income growth of 4.4% over the past five years.

Next, on comparing with the industry net income growth, we found that Novanta’s reported growth was lower than the industry growth of 16% in the same period, which is not something we like to see.

past-earnings-growth

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Novanta’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Novanta Making Efficient Use Of Its Profits?

Novanta doesn’t pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. However, there’s only been very little earnings growth to show for it. So there could be some other explanation in that regard. For instance, the company’s business may be deteriorating.

Conclusion

On the whole, we feel that the performance shown by Novanta can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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.