Most readers would already be aware that Excelsior Capital's (ASX:ECL) stock increased significantly by 20% 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 Excelsior Capital'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Excelsior Capital

How Is ROE Calculated?

ROE 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 Excelsior Capital is:

13% = AU$8.0m ÷ AU$60m (Based on the trailing twelve months to June 2022).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.13 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. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Excelsior Capital's Earnings Growth And 13% ROE

At first glance, Excelsior Capital seems to have a decent ROE. On comparing with the average industry ROE of 5.3% the company's ROE looks pretty remarkable. This certainly adds some context to Excelsior Capital's decent 15% net income growth seen over the past five years.

As a next step, we compared Excelsior Capital'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 15% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Excelsior Capital's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Excelsior Capital Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 30% (implying that the company retains 70% of its profits), it seems that Excelsior Capital is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Excelsior Capital has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

On the whole, we feel that Excelsior Capital's performance has been quite good. 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. Our risks dashboard will have the 1 risk we have identified for Excelsior Capital.

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.

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