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Redox (ASX:RDX) shares have risen by a remarkable 15% over the past three months. As most people know, fundamentals are what determine market price movements over the long term, so today we decided to examine the company’s key financial indicators to see if they play a role in the recent price movement. Specifically, we decided to examine Redox’s return on equity in this article.

Return on equity (ROE) is a measure of how effectively a company increases its value and manages its investors’ money. In simpler terms, it measures a company’s profitability relative to shareholders’ equity.

Check out our latest analysis for Redox

How do you calculate return on equity?

The Formula for ROE Is:

Return on equity = Net profit (from continuing operations) ÷ Equity

Based on the above formula, the ROE for Redox is:

16% = AU$83 million ÷ AU$512 million (based on the trailing twelve months to December 2023).

The “return” is the income that the company generated in the last year. You can also imagine it like this: for every Australian dollar of equity, the company was able to generate 0.16 Australian dollars in profit.

What does return on equity (ROE) have to do with earnings growth?

So far, we have learned that return on equity is a measure of a company’s profitability. Based on how much of its profits the company reinvests or “retains,” we can then judge a company’s future ability to generate profits. Generally speaking, all other things being equal, companies with high return on equity and retention of profits will have a higher growth rate than companies that do not have these characteristics.

Redox earnings growth and 16% ROE

First of all, Redox appears to have a respectable return on equity. Moreover, the company’s return on equity is quite favorable compared to the industry average of 11%. This has likely laid the foundation for Redox’s significant 21% net income growth over the past five years. However, there could be other reasons for this growth, such as high profit retention or efficient management.

Next, we compared Redox’s net income growth with that of the industry and were disappointed to find that the company’s growth was below the average industry growth of 27% over the same period.

Past profit growthPast profit growth

Past profit growth

The basis for valuing a company depends heavily on its earnings growth. Next, investors need to determine whether the expected earnings growth, or lack thereof, is already factored into the stock price. This then helps them determine whether the stock is positioned for a good or bad future. If you’re wondering about Redox’s valuation, check out this gauge of its price-to-earnings ratio compared to the industry.

Does Redox reinvest its profits efficiently?

The really high three-year median payout ratio of 18,235% for Redox suggests that the company is paying shareholders more than it earns. Despite this, the company has been able to grow its earnings significantly, as we saw above. However, it might be worth keeping an eye on the high payout ratio, as it represents a big risk.

Our latest analyst data shows that the company’s forward payout ratio is expected to decline to 75% over the next three years. Despite the lower forward payout ratio, the company’s return on equity is not expected to change significantly.

Diploma

Overall, we think Redox has some positives. As mentioned, earnings growth has been quite decent, and the high return on equity contributes to this growth. Yet, the company invests little to almost nothing of its earnings. This could potentially reduce the chances of the company continuing to see the same level of growth in the future. However, the company’s earnings growth is expected to slow down as forecast by the current analyst estimates. Are these analyst expectations based on broader expectations for the industry or on the company’s fundamentals? Click here to go to our analyst forecasts page for the company.

Do you have feedback on this article? Are you concerned about the content? Get in touch directly from us. Alternatively, send an email to editorial-team (at) simplywallst.com.

This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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