Pan African Resources' (LON:PAF) stock is up by a considerable 38% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Pan African Resources' ROE in this article.

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.

View our latest analysis for Pan African Resources

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 Pan African Resources is:

23% = US$74m ÷ US$327m (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ￡1 worth of shareholders' equity, the company generated ￡0.23 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. 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.

A Side By Side comparison of Pan African Resources' Earnings Growth And 23% ROE

Firstly, we acknowledge that Pan African Resources has a significantly high ROE. Secondly, even when compared to the industry average of 8.1% the company's ROE is quite impressive. This probably laid the groundwork for Pan African Resources' moderate 13% net income growth seen over the past five years.

As a next step, we compared Pan African Resources' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 9.9%.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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.