Ferrari (NYSE:RACE) has had a great run on the share market with its stock up by a significant 18% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Ferrari's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Ferrari

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 Ferrari is:

45% = €1.4b ÷ €3.1b (Based on the trailing twelve months to June 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 $0.45 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. 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.

Ferrari's Earnings Growth And 45% ROE

Firstly, we acknowledge that Ferrari has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 15% also doesn't go unnoticed by us. Probably as a result of this, Ferrari was able to see a decent net income growth of 16% over the last five years.

We then performed a comparison between Ferrari's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 16% in the same 5-year period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Ferrari fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Ferrari Using Its Retained Earnings Effectively?

Ferrari has a three-year median payout ratio of 30%, which implies that it retains the remaining 70% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.