Most readers would already be aware that Pan African Resources' (LON:PAF) stock increased significantly by 26% 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 Pan African Resources' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Pan African Resources

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 Pan African Resources is:

21% = US$61m ÷ US$295m (Based on the trailing twelve months to June 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 ￡0.21 in profit.

Why Is ROE Important For 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. 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 Pan African Resources' Earnings Growth And 21% ROE

At first glance, Pan African Resources seems to have a decent ROE. On comparing with the average industry ROE of 9.8% the company's ROE looks pretty remarkable. This certainly adds some context to Pan African Resources' decent 20% net income growth seen over the past five years.

We then performed a comparison between Pan African Resources' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 18% 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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Pan African Resources''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.