Supreme (LON:SUP) has had a rough three months with its share price down 42%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Supreme'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Supreme

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 Supreme is:

43% = UK£14m ÷ UK£32m (Based on the trailing twelve months to March 2022).

The 'return' is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.43 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Supreme's Earnings Growth And 43% ROE

Firstly, we acknowledge that Supreme has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 13% also doesn't go unnoticed by us. This likely paved the way for the modest 15% net income growth seen by Supreme over the past five years. growth

Next, on comparing with the industry net income growth, we found that the growth figure reported by Supreme compares quite favourably to the industry average, which shows a decline of 9.2% in the same period.

Earnings growth is a huge factor in stock valuation. 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 Supreme is trading on a high P/E or a low P/E, relative to its industry.