adesso's (ETR:ADN1) stock is up by a considerable 10% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on adesso's ROE.

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.

See our latest analysis for adesso

How Is ROE Calculated?

Return on equity 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 adesso is:

1.6% = €3.4m ÷ €208m (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. That means that for every €1 worth of shareholders' equity, the company generated €0.02 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

A Side By Side comparison of adesso's Earnings Growth And 1.6% ROE

It is quite clear that adesso's ROE is rather low. Even compared to the average industry ROE of 11%, the company's ROE is quite dismal. As a result, adesso's flat earnings over the past five years doesn't come as a surprise given its lower ROE.

We then compared adesso's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 13% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for ADN1? You can find out in our latest intrinsic value infographic research report.

Is adesso Making Efficient Use Of Its Profits?

adesso's low three-year median payout ratio of 14%, (meaning the company retains86% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.

Moreover, adesso has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 12%. Still, forecasts suggest that adesso's future ROE will rise to 16% even though the the company's payout ratio is not expected to change by much.

Summary

In total, we're a bit ambivalent about adesso's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.