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Most readers would already be aware that Porvair's (LON:PRV) stock increased significantly by 8.8% over the past month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Porvair's ROE in this article.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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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 Porvair is:
11% = UK£17m ÷ UK£153m (Based on the trailing twelve months to November 2024).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.11 in profit.
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What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
A Side By Side comparison of Porvair's Earnings Growth And 11% ROE
To start with, Porvair's ROE looks acceptable. Be that as it may, the company's ROE is still quite lower than the industry average of 15%. Although, we can see that Porvair saw a modest net income growth of 12% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also provides some context to the earnings growth seen by the company.
As a next step, we compared Porvair'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 9.3%.