Diploma's (LON:DPLM) stock is up by a considerable 11% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Diploma's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Diploma

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 Diploma is:

13% = UK￡118m ÷ UK￡902m (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ￡1 of shareholders' capital it has, the company made ￡0.13 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Diploma's Earnings Growth And 13% ROE

To start with, Diploma's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 15%. This certainly adds some context to Diploma's moderate 17% net income growth seen over the past five years.

Next, on comparing Diploma's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 16% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Diploma's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.