EZZ Life Science Holdings' (ASX:EZZ) stock is up by a considerable 51% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on EZZ Life Science Holdings' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for EZZ Life Science Holdings

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for EZZ Life Science Holdings is:

20% = AU$2.5m ÷ AU$13m (Based on the trailing twelve months to December 2022).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.20 in profit.

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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

EZZ Life Science Holdings' Earnings Growth And 20% ROE

To begin with, EZZ Life Science Holdings seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. Probably as a result of this, EZZ Life Science Holdings was able to see a decent growth of 6.8% over the last five years.

As a next step, we compared EZZ Life Science Holdings' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 6.8% in the same period.

Earnings growth is a huge factor in stock valuation. 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. Is EZZ Life Science Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is EZZ Life Science Holdings Efficiently Re-investing Its Profits?

In EZZ Life Science Holdings' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 11% (or a retention ratio of 89%), which suggests that the company is investing most of its profits to grow its business.

Along with seeing a growth in earnings, EZZ Life Science Holdings only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 486% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 14%) over the same period.

Conclusion

In total, we are pretty happy with EZZ Life Science Holdings' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 3 risks we have identified for EZZ Life Science Holdings by visiting our risks dashboard for free on our platform here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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