It is hard to get excited after looking at Treatt's (LON:TET) recent performance, when its stock has declined 28% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Treatt's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Treatt

How Is ROE Calculated?

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 Treatt is:

8.2% = UK￡11m ÷ UK￡130m (Based on the trailing twelve months to March 2023).

The 'return' is the profit 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 ￡0.08 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. 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.

Treatt's Earnings Growth And 8.2% ROE

On the face of it, Treatt's ROE is not much to talk about. However, its ROE is similar to the industry average of 9.8%, so we won't completely dismiss the company. On the other hand, Treatt reported a moderate 9.3% net income growth over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.

We then compared Treatt's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 5.8% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 TET? You can find out in our latest intrinsic value infographic research report.