NZME's (NZSE:NZM) stock is up by a considerable 11% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to NZME's ROE today.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for NZME

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for NZME is:

9.7% = NZ$12m ÷ NZ$125m (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.10 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. 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.

NZME's Earnings Growth And 9.7% ROE

On the face of it, NZME's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.7%. Particularly, the exceptional 58% net income growth seen by NZME over the past five years is pretty remarkable. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared NZME's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 41%.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about NZME's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.