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With its stock down 16% over the past three months, it is easy to disregard Volex (LON:VLX). 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 Volex's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Volex
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 Volex is:
13% = US$45m ÷ US$353m (Based on the trailing twelve months to September 2024).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.13 in profit.
What Is The Relationship Between ROE And 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.
Volex's Earnings Growth And 13% ROE
To start with, Volex's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 13%. Consequently, this likely laid the ground for the decent growth of 15% seen over the past five years by Volex.
Next, on comparing with the industry net income growth, we found that Volex's growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is VLX fairly valued? This infographic on the company's intrinsic value has everything you need to know.