BlueScope Steel's (ASX:BSL) stock is up by a considerable 11% 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 BlueScope Steel's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 BlueScope Steel

How Is ROE Calculated?

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 BlueScope Steel is:

28% = AU$2.7b ÷ AU$9.6b (Based on the trailing twelve months to December 2021).

The 'return' is the yearly profit. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.28 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

BlueScope Steel's Earnings Growth And 28% ROE

To begin with, BlueScope Steel has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 16% which is quite remarkable. This likely paved the way for the modest 5.6% net income growth seen by BlueScope Steel over the past five years. growth

Next, on comparing with the industry net income growth, we found that BlueScope Steel's reported growth was lower than the industry growth of 25% in the same period, which is not something we like 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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about BlueScope Steel's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is BlueScope Steel Using Its Retained Earnings Effectively?

BlueScope Steel's three-year median payout ratio to shareholders is 12% (implying that it retains 88% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.