It is hard to get excited after looking at Advanced Energy Industries' (NASDAQ:AEIS) recent performance, when its stock has declined 18% over the past three months. 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. Particularly, we will be paying attention to Advanced Energy Industries' ROE today.

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.

See our latest analysis for Advanced Energy Industries

How To Calculate Return On Equity?

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 Advanced Energy Industries is:

13% = US$138m ÷ US$1.1b (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 $0.13 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 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 Advanced Energy Industries' Earnings Growth And 13% ROE

To start with, Advanced Energy Industries' ROE looks acceptable. Even when compared to the industry average of 11% the company's ROE looks quite decent. This probably goes some way in explaining Advanced Energy Industries' moderate 16% growth over the past five years amongst other factors.

We then performed a comparison between Advanced Energy Industries' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 15% in the same 5-year period.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Advanced Energy Industries''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Advanced Energy Industries Efficiently Re-investing Its Profits?

In Advanced Energy Industries' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 8.4% (or a retention ratio of 92%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Advanced Energy Industries is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend.

Conclusion

On the whole, we feel that Advanced Energy Industries' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.