Red River Resources (ASX:RVR) has had a rough three months with its share price down 24%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Red River Resources' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Red River Resources

How To Calculate Return On Equity?

Return on equity 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 Red River Resources is:

9.8% = AU$5.9m ÷ AU$60m (Based on the trailing twelve months to June 2021).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.10 in profit.

Why Is ROE Important For 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. 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.

Red River Resources' Earnings Growth And 9.8% ROE

When you first look at it, Red River Resources' ROE doesn't look that attractive. Next, when compared to the average industry ROE of 14%, the company's ROE leaves us feeling even less enthusiastic. However, we we're pleasantly surprised to see that Red River Resources grew its net income at a significant rate of 33% in the last five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Red River Resources' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 24%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Red River Resources''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.