Treatt (LON:TET) has had a rough three months with its share price down 19%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Treatt's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Treatt

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 Treatt is:

8.0% = UK￡11m ÷ UK￡137m (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ￡1 of shareholders' capital it has, the company made ￡0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 Treatt's Earnings Growth And 8.0% ROE

On the face of it, Treatt's ROE is not much to talk about. However, its ROE is similar to the industry average of 7.6%, so we won't completely dismiss the company. Even so, Treatt has shown a fairly decent growth in its net income which grew at a rate of 6.4%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.

When you consider the fact that the industry earnings have shrunk at a rate of 2.5% in the same 5-year period, the company's net income growth is pretty remarkable.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is TET fairly valued? This infographic on the company's intrinsic value has everything you need to know.