Most readers would already be aware that Energy Services of America's (NASDAQ:ESOA) stock increased significantly by 34% 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. Specifically, we decided to study Energy Services of America's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Energy Services of America

How To Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Energy Services of America is:

46% = US$24m ÷ US$52m (Based on the trailing twelve months to June 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 $0.46 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Energy Services of America's Earnings Growth And 46% ROE

To begin with, Energy Services of America has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. So, the substantial 48% net income growth seen by Energy Services of America over the past five years isn't overly surprising.

As a next step, we compared Energy Services of America's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 48% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Energy Services of America is trading on a high P/E or a low P/E, relative to its industry.

Is Energy Services of America Using Its Retained Earnings Effectively?

Energy Services of America's ' three-year median payout ratio is on the lower side at 9.9% implying that it is retaining a higher percentage (90%) of its profits. So it looks like Energy Services of America is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, Energy Services of America has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

Overall, we are quite pleased with Energy Services of America's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.