Most readers would already know that Probiotec's (ASX:PBP) stock increased by 3.7% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Probiotec's 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.
Check out our latest analysis for Probiotec
How Do You 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 Probiotec is:
17% = AU$14m ÷ AU$79m (Based on the trailing twelve months to June 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$0.17 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
Probiotec's Earnings Growth And 17% ROE
At first glance, Probiotec seems to have a decent ROE. Even when compared to the industry average of 18% the company's ROE looks quite decent. This probably goes some way in explaining Probiotec's significant 30% net income growth over the past five years amongst other factors. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.
We then performed a comparison between Probiotec's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 30% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Probiotec fairly valued compared to other companies? These 3 valuation measures might help you decide.