Rectifier Technologies (ASX:RFT) has had a rough three months with its share price down 35%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Rectifier Technologies' ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
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 Rectifier Technologies is:
25% = AU$2.3m ÷ AU$9.3m (Based on the trailing twelve months to December 2019).
The 'return' is the income the business earned over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.25 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learnt that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Rectifier Technologies' Earnings Growth And 25% ROE
To begin with, Rectifier Technologies has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 7.8% also doesn't go unnoticed by us. Under the circumstances, Rectifier Technologies' considerable five year net income growth of 26% was to be expected.
As a next step, we compared Rectifier Technologies' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 4.6%.
Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Rectifier Technologies''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Rectifier Technologies Using Its Retained Earnings Effectively?
Rectifier Technologies doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.
Overall, we are quite pleased with Rectifier Technologies' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 2 risks we have identified for Rectifier Technologies by visiting our risks dashboard for free on our platform here.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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