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.