It is hard to get excited after looking at Reliance Worldwide's (ASX:RWC) recent performance, when its stock has declined 17% over the past month. 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 Reliance Worldwide's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Reliance Worldwide

How To 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 Reliance Worldwide is:

12% = US$137m ÷ US$1.1b (Based on the trailing twelve months to June 2022).

The 'return' is the income the business earned over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.12 in profit.

What Is The Relationship Between ROE And 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Reliance Worldwide's Earnings Growth And 12% ROE

At first glance, Reliance Worldwide seems to have a decent ROE. Even when compared to the industry average of 12% the company's ROE looks quite decent. This probably goes some way in explaining Reliance Worldwide's significant 22% net income growth over the past five years amongst other factors. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Reliance Worldwide's 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 period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Reliance Worldwide fairly valued compared to other companies? These 3 valuation measures might help you decide.