It is hard to get excited after looking at Aurizon Holdings' (ASX:AZJ) recent performance, when its stock has declined 13% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Aurizon Holdings' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Aurizon Holdings

How Do You 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 Aurizon Holdings is:

12% = AU$513m ÷ AU$4.4b (Based on the trailing twelve months to June 2022).

The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.12.

What Is The Relationship Between ROE And Earnings Growth?

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

Aurizon Holdings' Earnings Growth And 12% ROE

To begin with, Aurizon Holdings seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.3%. This probably laid the ground for Aurizon Holdings' moderate 20% net income growth seen over the past five years.

As a next step, we compared Aurizon Holdings' 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 11%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is AZJ fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Aurizon Holdings Making Efficient Use Of Its Profits?

While Aurizon Holdings has a three-year median payout ratio of 88% (which means it retains 12% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.