Advanced Braking Technology (ASX:ABV) has had a rough month with its share price down 15%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Advanced Braking Technology's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Advanced Braking Technology

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 Advanced Braking Technology is:

13% = AU$1.2m ÷ AU$9.3m (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.13 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Advanced Braking Technology's Earnings Growth And 13% ROE

To start with, Advanced Braking Technology's ROE looks acceptable. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. This certainly adds some context to Advanced Braking Technology's exceptional 42% net income growth seen over the past five years. We reckon that there could also be other factors at play here. 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.

We then compared Advanced Braking Technology's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 8.6% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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 Advanced Braking Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Advanced Braking Technology Using Its Retained Earnings Effectively?

Given that Advanced Braking Technology doesn't pay any regular dividends to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

In total, we are pretty happy with Advanced Braking Technology's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 2 risks we have identified for Advanced Braking Technology by visiting our risks dashboard for free on our platform here.

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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.