Most readers would already be aware that Waterco's (ASX:WAT) stock increased significantly by 34% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Waterco's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Waterco

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 Waterco is:

11% = AU$14m ÷ AU$130m (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.11 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Waterco's Earnings Growth And 11% ROE

To begin with, Waterco seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 11%. Consequently, this likely laid the ground for the impressive net income growth of 22% seen over the past five years by Waterco. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Waterco's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 12%.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Waterco's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Waterco Efficiently Re-investing Its Profits?

Waterco has a three-year median payout ratio of 30% (where it is retaining 70% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Waterco is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Waterco has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

On the whole, we feel that Waterco's performance has been quite good. 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.

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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.