It is hard to get excited after looking at Praemium's (ASX:PPS) recent performance, when its stock has declined 8.0% over the past month. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Praemium's ROE in this article.

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.

View our latest analysis for Praemium

How Do You Calculate Return On Equity?

Return on equity 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 Praemium is:

9.5% = AU$10m ÷ AU$106m (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.10.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Praemium's Earnings Growth And 9.5% ROE

At first glance, Praemium's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 10%, we may spare it some thought. Moreover, we are quite pleased to see that Praemium's net income grew significantly at a rate of 33% over the last five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Praemium's 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 27%.

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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for PPS? You can find out in our latest intrinsic value infographic research report.