It is hard to get excited after looking at Adacel Technologies' (ASX:ADA) recent performance, when its stock has declined 15% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Adacel Technologies' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Adacel Technologies

How To Calculate Return On Equity?

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 Adacel Technologies is:

23% = US$3.3m ÷ US$14m (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.23.

What Is The Relationship Between ROE And Earnings Growth?

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

A Side By Side comparison of Adacel Technologies' Earnings Growth And 23% ROE

To begin with, Adacel Technologies has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 9.7% also doesn't go unnoticed by us. Needless to say, we are quite surprised to see that Adacel Technologies' net income shrunk at a rate of 12% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

So, as a next step, we compared Adacel Technologies' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 20% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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 Adacel Technologies''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.