Auto Trader Group (LON:AUTO) has had a great run on the share market with its stock up by a significant 7.5% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Auto Trader Group's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Auto Trader Group

How Do You 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 Auto Trader Group is:

47% = UK￡257m ÷ UK￡552m (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ￡1 of shareholders' capital it has, the company made ￡0.47 in profit.

What Has ROE Got To Do With 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Auto Trader Group's Earnings Growth And 47% ROE

Firstly, we acknowledge that Auto Trader Group has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 18% also doesn't go unnoticed by us. This probably laid the groundwork for Auto Trader Group's moderate 6.9% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Auto Trader Group's reported growth was lower than the industry growth of 18% over the last few years, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. 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. Is AUTO fairly valued? This infographic on the company's intrinsic value has everything you need to know.