With its stock down 5.0% over the past three months, it is easy to disregard Rectifier Technologies (ASX:RFT). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Rectifier Technologies' ROE in this article.
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.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Rectifier Technologies is:
19% = AU$1.8m ÷ AU$9.6m (Based on the trailing twelve months to June 2020).
The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.19.
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 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 Rectifier Technologies' Earnings Growth And 19% ROE
To begin with, Rectifier Technologies seems to have a respectable ROE. On comparing with the average industry ROE of 7.9% the company's ROE looks pretty remarkable. This certainly adds some context to Rectifier Technologies' exceptional 26% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing with the industry net income growth, we found that Rectifier Technologies' 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. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Rectifier Technologies fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Rectifier Technologies Efficiently Re-investing Its Profits?
Rectifier Technologies has a significant three-year median payout ratio of 75%, meaning the company only retains 25% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.
On the whole, we feel that Rectifier Technologies' performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Up till now, we've only made a short study of the company's growth data. You can do your own research on Rectifier Technologies and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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