Nick Scali's (ASX:NCK) stock is up by a considerable 6.9% over the past week. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Nick Scali's ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Nick Scali

How Do You Calculate Return On Equity?

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 Nick Scali is:

31% = AU$81m ÷ AU$258m (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.31.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Nick Scali's Earnings Growth And 31% ROE

First thing first, we like that Nick Scali has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 17% also doesn't go unnoticed by us. This likely paved the way for the modest 16% net income growth seen by Nick Scali over the past five years.

We then performed a comparison between Nick Scali's 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.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Nick Scali fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Nick Scali Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 64% (or a retention ratio of 36%) for Nick Scali suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, Nick Scali has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 69%. Accordingly, forecasts suggest that Nick Scali's future ROE will be 29% which is again, similar to the current ROE.

Summary

On the whole, we feel that Nick Scali's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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