Most readers would already know that Exxaro Resources' (JSE:EXX) stock increased by 6.3% 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. Particularly, we will be paying attention to Exxaro Resources' 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.

See our latest analysis for Exxaro Resources

How Do You Calculate Return On Equity?

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 Exxaro Resources is:

29% = R17b ÷ R57b (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 ZAR1 of its shareholder's investments, the company generates a profit of ZAR0.29.

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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Exxaro Resources' Earnings Growth And 29% ROE

To begin with, Exxaro Resources seems to have a respectable ROE. On comparing with the average industry ROE of 21% the company's ROE looks pretty remarkable. This probably laid the ground for Exxaro Resources' significant 20% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Exxaro 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 14%.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Exxaro Resources is trading on a high P/E or a low P/E, relative to its industry.