With its stock down 41% over the past three months, it is easy to disregard Rectifier Technologies (ASX:RFT). 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 Rectifier Technologies' ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You Calculate Return On Equity?
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 Rectifier Technologies is:
3.8% = AU$350k ÷ AU$9.2m (Based on the trailing twelve months to December 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.04 in profit.
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. 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 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.
Rectifier Technologies' Earnings Growth And 3.8% ROE
As you can see, Rectifier Technologies' ROE looks pretty weak. Even when compared to the industry average of 12%, the ROE figure is pretty disappointing. However, the moderate 7.5% net income growth seen by Rectifier Technologies over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Rectifier Technologies' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 24% in the same period, which is a bit concerning.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Rectifier Technologies is trading on a high P/E or a low P/E, relative to its industry.
Is Rectifier Technologies Using Its Retained Earnings Effectively?
While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.
On the whole, we do feel that Rectifier Technologies has some positive attributes. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on Rectifier Technologies and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.
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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.