With its stock down 18% over the past three months, it is easy to disregard Wellington Drive Technologies (NZSE:WDT). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Wellington Drive Technologies' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Wellington Drive Technologies

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 Wellington Drive Technologies is:

27% = NZ$5.4m ÷ NZ$20m (Based on the trailing twelve months to December 2021).

The 'return' is the profit over the last twelve months. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.27 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Wellington Drive Technologies' Earnings Growth And 27% ROE

Firstly, we acknowledge that Wellington Drive Technologies has a significantly high ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. Under the circumstances, Wellington Drive Technologies' considerable five year net income growth of 47% was to be expected.

As a next step, we compared Wellington Drive Technologies' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.

Earnings growth is an important metric to consider when valuing a stock. 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 Wellington Drive Technologies is trading on a high P/E or a low P/E, relative to its industry.

Is Wellington Drive Technologies Using Its Retained Earnings Effectively?

Wellington Drive Technologies doesn't pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what's driving the high earnings growth number discussed above.

Summary

On the whole, we feel that Wellington Drive Technologies' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial 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 Wellington Drive Technologies 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.