Nick Scali's (ASX:NCK) stock is up by a considerable 17% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Nick Scali's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Nick Scali

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 Nick Scali is:

53% = AU$75m ÷ AU$141m (Based on the trailing twelve months to June 2022).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.53 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Nick Scali's Earnings Growth And 53% ROE

First thing first, we like that Nick Scali has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 21% also doesn't go unnoticed by us. Probably as a result of this, Nick Scali was able to see a decent net income growth of 18% over the last five years.

We then performed a comparison between Nick Scali's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 21% 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. Doing so will help them establish if the stock's future looks promising or ominous. 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 has a significant three-year median payout ratio of 83%, meaning that it is left with only 17% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.