5E Resources' (Catalist:NLC) stock is up by a considerable 5.8% over the past month. 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 5E Resources' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for 5E Resources

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 5E Resources is:

13% = RM12m ÷ RM96m (Based on the trailing twelve months to December 2022).

The 'return' is the yearly profit. So, this means that for every SGD1 of its shareholder's investments, the company generates a profit of SGD0.13.

What Is The Relationship Between ROE And Earnings Growth?

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

A Side By Side comparison of 5E Resources' Earnings Growth And 13% ROE

To start with, 5E Resources' ROE looks acceptable. On comparing with the average industry ROE of 6.4% the company's ROE looks pretty remarkable. This certainly adds some context to 5E Resources' decent 11% net income growth seen over the past five years.

As a next step, we compared 5E Resources' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 14% in the same 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. 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 5E Resources is trading on a high P/E or a low P/E, relative to its industry.

Is 5E Resources Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 35% (implying that the company retains 65% of its profits), it seems that 5E Resources is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Conclusion

On the whole, we feel that 5E Resources' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 3 risks we have identified for 5E Resources by visiting our risks dashboard for free on our platform here.

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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here