Nick Scali (ASX:NCK) has had a great run on the share market with its stock up by a significant 13% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Nick Scali's ROE.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Nick Scali

How To 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 Nick Scali is:

31% = AU$81m ÷ AU$258m (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.31 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. 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. 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.

A Side By Side comparison of Nick Scali's Earnings Growth And 31% ROE

To begin with, Nick Scali has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 17% the company's ROE is quite impressive. This likely paved the way for the modest 16% net income growth seen by Nick Scali over the past five years.

We then performed a comparison between Nick Scali's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 15% in the same 5-year period.

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. If you're wondering about Nick Scali's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.