With its stock down 9.4% over the past three months, it is easy to disregard Stabilus (ETR:STM). 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 Stabilus' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Stabilus

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 Stabilus is:

14% = €100m ÷ €696m (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.14 in profit.

Why Is ROE Important For 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 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.

Stabilus' Earnings Growth And 14% ROE

At first glance, Stabilus seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. This certainly adds some context to Stabilus' decent 7.5% net income growth seen over the past five years.

We then compared Stabilus' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 15% in the same 5-year period, which is a bit concerning.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Stabilus''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.