With its stock down 28% over the past three months, it is easy to disregard Neuren Pharmaceuticals (ASX:NEU). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Neuren Pharmaceuticals' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Neuren Pharmaceuticals

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 Neuren Pharmaceuticals is:

77% = AU$157m ÷ AU$205m (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.77 in profit.

Why Is ROE Important For 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. 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.

Neuren Pharmaceuticals' Earnings Growth And 77% ROE

To begin with, Neuren Pharmaceuticals has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 19% which is quite remarkable. As a result, Neuren Pharmaceuticals' exceptional 77% net income growth seen over the past five years, doesn't come as a surprise.

Next, on comparing with the industry net income growth, we found that Neuren Pharmaceuticals' growth is quite high when compared to the industry average growth of 36% in the same period, which is great to see.

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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Neuren Pharmaceuticals is trading on a high P/E or a low P/E, relative to its industry.