Rotork's (LON:ROR) stock is up by 5.3% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Rotork's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Rotork

How To Calculate Return On Equity?

The formula for return on equity is:

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

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

18% = UK￡113m ÷ UK￡622m (Based on the trailing twelve months to December 2023).

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 ￡0.18 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.

Rotork's Earnings Growth And 18% ROE

To start with, Rotork's ROE looks acceptable. Especially when compared to the industry average of 14% the company's ROE looks pretty impressive. However, for some reason, the higher returns aren't reflected in Rotork's meagre five year net income growth average of 2.2%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that Rotork's reported growth was lower than the industry growth of 9.8% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is Rotork fairly valued compared to other companies? These 3 valuation measures might help you decide.