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Reliance (NYSE:RS) has had a rough month with its share price down 16%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Reliance's ROE today.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Reliance
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 Reliance is:
14% = US$1.0b ÷ US$7.4b (Based on the trailing twelve months to September 2024).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.14 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Reliance's Earnings Growth And 14% ROE
To begin with, Reliance seems to have a respectable ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. This certainly adds some context to Reliance's decent 19% net income growth seen over the past five years.
Next, on comparing Reliance's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 23% over the last few years.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Reliance is trading on a high P/E or a low P/E, relative to its industry.