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It is hard to get excited after looking at Pason Systems' (TSE:PSI) recent performance, when its stock has declined 6.7% over the past month. 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. In this article, we decided to focus on Pason Systems' ROE.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Pason Systems
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Pason Systems is:
24% = CA$111m ÷ CA$473m (Based on the trailing twelve months to September 2024).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.24 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Pason Systems' Earnings Growth And 24% ROE
Firstly, we acknowledge that Pason Systems has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 15% which is quite remarkable. So, the substantial 33% net income growth seen by Pason Systems over the past five years isn't overly surprising.
As a next step, we compared Pason Systems' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 56% in the same period.
Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Pason Systems''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.