ESAB's (NYSE:ESAB) stock is up by a considerable 25% over the past three months. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. Specifically, we decided to study ESAB's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for ESAB is:

15% = US$252m ÷ US$1.7b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.15 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. 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.

ESAB's Earnings Growth And 15% ROE

To begin with, ESAB seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. This probably goes some way in explaining ESAB's moderate 6.3% growth over the past five years amongst other factors.

We then performed a comparison between ESAB's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 7.4% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is ESAB fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is ESAB Using Its Retained Earnings Effectively?

ESAB has a low three-year median payout ratio of 5.3%, meaning that the company retains the remaining 95% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

While ESAB has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 5.2% of its profits over the next three years. Accordingly, forecasts suggest that ESAB's future ROE will be 14% which is again, similar to the current ROE.

Conclusion

Overall, we are quite pleased with ESAB's performance. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.