It is hard to get excited after looking at Associated British Foods' (LON:ABF) recent performance, when its stock has declined 3.3% over the past month. 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. Specifically, we decided to study Associated British Foods' ROE in this article.

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 Associated British Foods

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Associated British Foods is:

11% = UK￡1.2b ÷ UK￡11b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ￡1 of shareholders' capital it has, the company made ￡0.11 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Associated British Foods' Earnings Growth And 11% ROE

To start with, Associated British Foods' ROE looks acceptable. Even when compared to the industry average of 11% the company's ROE looks quite decent. This certainly adds some context to Associated British Foods' moderate 7.4% net income growth seen over the past five years.

Next, on comparing Associated British Foods' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 9.0% over the last few years.

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. Is Associated British Foods fairly valued compared to other companies? These 3 valuation measures might help you decide.