Most readers would already be aware that Nortech Systems' (NASDAQ:NSYS) stock increased significantly by 29% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Nortech Systems' ROE today.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Nortech Systems

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 Nortech Systems is:

26% = US$7.4m ÷ US$28m (Based on the trailing twelve months to September 2022).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.26 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 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.

Nortech Systems' Earnings Growth And 26% ROE

First thing first, we like that Nortech Systems has an impressive ROE. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. So, the substantial 59% net income growth seen by Nortech Systems over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Nortech Systems' growth is quite high when compared to the industry average growth of 18% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Nortech Systems''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Nortech Systems Making Efficient Use Of Its Profits?

Nortech Systems doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Summary

Overall, we are quite pleased with Nortech Systems' 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 2 risks we have identified for Nortech Systems by visiting our risks dashboard for free on our platform here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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