It is hard to get excited after looking at Babylon Pump & Power's (ASX:BPP) recent performance, when its stock has declined 17% over the past week. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Babylon Pump & Power's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Babylon Pump & Power

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 Babylon Pump & Power is:

4.6% = AU$508k ÷ AU$11m (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.05 in profit.

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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

At first glance, Babylon Pump & Power's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.1% either. However, the moderate 11% net income growth seen by Babylon Pump & Power over the past five years is definitely a positive. So, there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Babylon Pump & Power's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 25% in the same period.

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. 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 Babylon Pump & Power is trading on a high P/E or a low P/E, relative to its industry.