Most readers would already be aware that ESAB's (NYSE:ESAB) stock increased significantly by 41% 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. Particularly, we will be paying attention to ESAB's ROE today.

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.

See our latest analysis for ESAB

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for ESAB is:

15% = US$224m ÷ US$1.5b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.15 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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

ESAB's Earnings Growth And 15% ROE

To begin with, ESAB seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 15%. This certainly adds some context to ESAB's moderate 6.3% net income growth seen over the past five years.

We then compared ESAB's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 8.8% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. What is ESAB worth today? The intrinsic value infographic in our free research report helps visualize whether ESAB is currently mispriced by the market.

Is ESAB Using Its Retained Earnings Effectively?

ESAB has a low three-year median payout ratio of 4.5%, meaning that the company retains the remaining 95% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Along with seeing a growth in earnings, ESAB only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 5.2%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 17%.

Summary

In total, we are pretty happy with ESAB'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 a good amount of growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.