Most readers would already know that Knorr-Bremse's (ETR:KBX) stock increased by 5.2% 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 Knorr-Bremse's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Knorr-Bremse

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 Knorr-Bremse is:

21% = €628m ÷ €3.0b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. That means that for every €1 worth of shareholders' equity, the company generated €0.21 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Knorr-Bremse's Earnings Growth And 21% ROE

Firstly, we acknowledge that Knorr-Bremse has a significantly high ROE. Secondly, even when compared to the industry average of 10% the company's ROE is quite impressive. However, we are curious as to how the high returns still resulted in a flat growth for Knorr-Bremse in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

We then compared Knorr-Bremse's net income growth with the industry and found that the average industry growth rate was 15% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is KBX worth today? The intrinsic value infographic in our free research report helps visualize whether KBX is currently mispriced by the market.