It is hard to get excited after looking at Drilling Tools International's (NASDAQ:DTI) recent performance, when its stock has declined 12% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Drilling Tools International's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Drilling Tools International

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Drilling Tools International is:

6.6% = US$8.2m ÷ US$123m (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.07 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Drilling Tools International's Earnings Growth And 6.6% ROE

At first glance, Drilling Tools International's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 14%. Despite this, surprisingly, Drilling Tools International saw an exceptional 45% net income growth over the past five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Drilling Tools International's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 54% in the same period.

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. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Drilling Tools International is trading on a high P/E or a low P/E, relative to its industry.

Is Drilling Tools International Using Its Retained Earnings Effectively?

Given that Drilling Tools International doesn't pay any regular dividends to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

In total, it does look like Drilling Tools International has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.