Most readers would already be aware that Carl Zeiss Meditec's (ETR:AFX) stock increased significantly by 19% over the past month. 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 Carl Zeiss Meditec's ROE.

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.

Check out our latest analysis for Carl Zeiss Meditec

How Is ROE Calculated?

ROE 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 Carl Zeiss Meditec is:

9.6% = €203m ÷ €2.1b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.10 in profit.

What Has ROE Got To Do With 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.

Carl Zeiss Meditec's Earnings Growth And 9.6% ROE

To start with, Carl Zeiss Meditec's ROE looks acceptable. Even when compared to the industry average of 9.6% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 15% seen over the past five years by Carl Zeiss Meditec.

Given that the industry shrunk its earnings at a rate of 1.1% over the last few years, the net income growth of the company is quite impressive.

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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Carl Zeiss Meditec is trading on a high P/E or a low P/E, relative to its industry.