Most readers would already be aware that Neuren Pharmaceuticals' (ASX:NEU) stock increased significantly by 22% 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. In this article, we decided to focus on Neuren Pharmaceuticals' ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Neuren Pharmaceuticals

How Is ROE Calculated?

Return on equity 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 Neuren Pharmaceuticals is:

77% = AU$157m ÷ AU$205m (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 A$1 worth of shareholders' equity, the company generated A$0.77 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Neuren Pharmaceuticals' Earnings Growth And 77% ROE

Firstly, we acknowledge that Neuren Pharmaceuticals has a significantly high ROE. Secondly, even when compared to the industry average of 21% the company's ROE is quite impressive. As a result, Neuren Pharmaceuticals' exceptional 77% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Neuren Pharmaceuticals' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 34% in the same 5-year 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. If you're wondering about Neuren Pharmaceuticals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.