It is hard to get excited after looking at Northern Technologies International's (NASDAQ:NTIC) recent performance, when its stock has declined 17% 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. Specifically, we decided to study Northern Technologies International'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Northern Technologies International

How Is ROE Calculated?

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 Northern Technologies International is:

8.1% = US$6.0m ÷ US$74m (Based on the trailing twelve months to November 2024).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.08 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Northern Technologies International's Earnings Growth And 8.1% ROE

On the face of it, Northern Technologies International's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 10%, we may spare it some thought. On the other hand, Northern Technologies International reported a moderate 12% net income growth over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving 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 Northern Technologies International's growth is quite high when compared to the industry average growth of 9.3% in the same period, which is great to see.

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

Is Northern Technologies International Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 57% (or a retention ratio of 43%) for Northern Technologies International suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, Northern Technologies International has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

Overall, we feel that Northern Technologies International certainly does have some positive factors to consider. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

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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.