Nick Scali's (ASX:NCK) stock is up by a considerable 11% 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. Specifically, we decided to study Nick Scali's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Nick Scali

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 Nick Scali is:

61% = AU$102m ÷ AU$168m (Based on the trailing twelve months to December 2022).

The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.61 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

A Side By Side comparison of Nick Scali's Earnings Growth And 61% ROE

Firstly, we acknowledge that Nick Scali has a significantly high ROE. Secondly, even when compared to the industry average of 20% the company's ROE is quite impressive. Under the circumstances, Nick Scali's considerable five year net income growth of 20% was to be expected.

As a next step, we compared Nick Scali's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 22% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for NCK? You can find out in our latest intrinsic value infographic research report.

Is Nick Scali Using Its Retained Earnings Effectively?

Nick Scali's significant three-year median payout ratio of 71% (where it is retaining only 29% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.