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It is hard to get excited after looking at Spectra Systems' (LON:SPSY) recent performance, when its stock has declined 4.9% over the past month. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Spectra Systems' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Spectra Systems
How Is ROE Calculated?
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 Spectra Systems is:
20% = US$6.6m ÷ US$33m (Based on the trailing twelve months to June 2024).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.20 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
A Side By Side comparison of Spectra Systems' Earnings Growth And 20% ROE
To start with, Spectra Systems' ROE looks acceptable. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. Probably as a result of this, Spectra Systems was able to see a decent growth of 13% over the last five years.
We then compared Spectra Systems' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 10% in the same 5-year 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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Spectra Systems is trading on a high P/E or a low P/E, relative to its industry.