Most readers would already be aware that CGI's (TSE:GIB.A) stock increased significantly by 16% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on CGI's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for CGI

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 CGI is:

19% = CA$1.7b ÷ CA$8.9b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.19 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

CGI's Earnings Growth And 19% ROE

To begin with, CGI seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 14%. This probably laid the ground for CGI's moderate 7.7% net income growth seen over the past five years.

Next, on comparing CGI's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 7.4% over the last few years.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for GIB.A? You can find out in our latest intrinsic value infographic research report.

Is CGI Using Its Retained Earnings Effectively?

CGI doesn't pay any regular dividends, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.