Most readers would already be aware that Paychex's (NASDAQ:PAYX) stock increased significantly by 19% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Paychex's ROE.

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.

View our latest analysis for Paychex

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 Paychex is:

44% = US$1.7b ÷ US$3.9b (Based on the trailing twelve months to August 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.44 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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 Paychex's Earnings Growth And 44% ROE

To begin with, Paychex has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 16% which is quite remarkable. Probably as a result of this, Paychex was able to see a decent net income growth of 11% over the last five years.

As a next step, we compared Paychex's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 9.9% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for PAYX? You can find out in our latest intrinsic value infographic research report.