Most readers would already be aware that Paycom Software's (NYSE:PAYC) stock increased significantly by 10% over the past three months. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Paycom Software's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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 Paycom Software is:

33% = US$472m ÷ US$1.4b (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 $0.33 in profit.

What Is The Relationship Between ROE And 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.

Paycom Software's Earnings Growth And 33% ROE

Firstly, we acknowledge that Paycom Software has a significantly high ROE. Secondly, even when compared to the industry average of 16% the company's ROE is quite impressive. As a result, Paycom Software's exceptional 23% net income growth seen over the past five years, doesn't come as a surprise.

Next, on comparing with the industry net income growth, we found that Paycom Software's growth is quite high when compared to the industry average growth of 9.9% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Paycom Software's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Paycom Software Efficiently Re-investing Its Profits?

Paycom Software has a really low three-year median payout ratio of 18%, meaning that it has the remaining 82% left over to reinvest into its business. So it looks like Paycom Software is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Along with seeing a growth in earnings, Paycom Software only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 16%. Regardless, Paycom Software's ROE is speculated to decline to 22% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we feel that Paycom Software's performance has been quite good. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.