It is hard to get excited after looking at nVent Electric's (NYSE:NVT) recent performance, when its stock has declined 7.9% over the past month. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study nVent Electric's ROE in this article.

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.

How Is ROE Calculated?

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 nVent Electric is:

18% = US$578m ÷ US$3.2b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.18 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. 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. 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.

nVent Electric's Earnings Growth And 18% ROE

To begin with, nVent Electric seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 12%. This certainly adds some context to nVent Electric's exceptional 30% net income growth seen over the past five years. However, there could also be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that nVent Electric's growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is NVT fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is nVent Electric Making Efficient Use Of Its Profits?

The three-year median payout ratio for nVent Electric is 29%, which is moderately low. The company is retaining the remaining 71%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like nVent Electric is reinvesting its earnings efficiently.

Moreover, nVent Electric is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 23% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we are quite pleased with nVent Electric'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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com