It is hard to get excited after looking at Spectra Products' (CVE:SSA) recent performance, when its stock has declined 15% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Spectra Products' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Spectra Products

How Do You Calculate Return On Equity?

Return on equity 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 Spectra Products is:

14% = CA$246k ÷ CA$1.8m (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.14 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. 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.

A Side By Side comparison of Spectra Products' Earnings Growth And 14% ROE

To start with, Spectra Products' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 9.1%. As you might expect, the 24% net income decline reported by Spectra Products is a bit of a surprise. Therefore, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 4.0% in the same 5-year period, we still found Spectra Products' performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Spectra Products fairly valued compared to other companies? These 3 valuation measures might help you decide.