XRF Scientific (ASX:XRF) has had a great run on the share market with its stock up by a significant 21% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study XRF Scientific'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 XRF Scientific

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 XRF Scientific is:

14% = AU$6.1m ÷ AU$43m (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.14 in profit.

Why Is ROE Important For 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.

XRF Scientific's Earnings Growth And 14% ROE

At first glance, XRF Scientific seems to have a decent ROE. Especially when compared to the industry average of 9.7% the company's ROE looks pretty impressive. This certainly adds some context to XRF Scientific's exceptional 39% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that XRF Scientific's growth is quite high when compared to the industry average growth of 9.5% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is XRF worth today? The intrinsic value infographic in our free research report helps visualize whether XRF is currently mispriced by the market.

Is XRF Scientific Efficiently Re-investing Its Profits?

XRF Scientific's significant three-year median payout ratio of 50% (where it is retaining only 50% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Besides, XRF Scientific has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 47% of its profits over the next three years. Accordingly, forecasts suggest that XRF Scientific's future ROE will be 14% which is again, similar to the current ROE.

Conclusion

In total, we are pretty happy with XRF Scientific's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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