PHINIA's (NYSE:PHIN) stock up by 9.5% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on PHINIA'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 PHINIA is:

4.3% = US$75m ÷ US$1.7b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.04 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 PHINIA's Earnings Growth And 4.3% ROE

It is quite clear that PHINIA's ROE is rather low. Not just that, even compared to the industry average of 13%, the company's ROE is entirely unremarkable. In spite of this, PHINIA was able to grow its net income considerably, at a rate of 26% in the last five years. Therefore, there could be other reasons behind this growth. 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.

As a next step, we compared PHINIA's 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 16%.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about PHINIA's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is PHINIA Using Its Retained Earnings Effectively?

The three-year median payout ratio for PHINIA is 30%, which is moderately low. The company is retaining the remaining 70%. By the looks of it, the dividend is well covered and PHINIA is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Along with seeing a growth in earnings, PHINIA only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 22% over the next three years. The fact that the company's ROE is expected to rise to 12% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, we do feel that PHINIA has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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.