Raspberry Pi Holdings (LON:RPI) has had a rough three months with its share price down 15%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Raspberry Pi Holdings' 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 Raspberry Pi Holdings

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 Raspberry Pi Holdings is:

20% = US$32m ÷ US$159m (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. That means that for every ￡1 worth of shareholders' equity, the company generated ￡0.20 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Raspberry Pi Holdings' Earnings Growth And 20% ROE

To start with, Raspberry Pi Holdings' ROE looks acceptable. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Probably as a result of this, Raspberry Pi Holdings was able to see an impressive net income growth of 25% over the last five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Raspberry Pi Holdings' growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Raspberry Pi Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.