Gentherm (NASDAQ:THRM) shares have risen 3.3% over the past week. We wonder if and what role the company’s financials play in this price change, as a company’s long-term fundamentals usually drive market results. In this article, we have chosen to focus on Gentherm’s return on equity.

ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investments it receives from its shareholders. Simply put, it is used to evaluate the profitability of a company relative to its equity.

Check out our latest analysis for Gentherm

How do you calculate return on equity?

ROE can be calculated using the following formula:

Return on equity = Net profit (from continuing operations) ÷ Equity

Based on the above formula, the ROE for Gentherm is:

11% = $68 million ÷ $640 million (based on the trailing twelve months ending June 2024).

The “return” is the income that the company generated in the last year. You can think of it like this: for every dollar of shareholder capital, the company made $0.11 in profit.

What does return on equity (ROE) have to do with earnings growth?

So far, we’ve learned that return on equity (ROE) measures how efficiently a company generates its profits. Depending on how much of those profits the company reinvests or “retains” and how effectively it does so, we can then assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the return on equity and earnings retention, the higher a company’s growth rate will be compared to companies that don’t necessarily have those characteristics.

A comparison of Gentherm’s earnings growth and return on equity of 11%

First of all, Gentherm appears to have a respectable return on equity. And when comparing the industry, we found that the industry average return on equity is similarly high at 12%. Although Gentherm has a fairly respectable return on equity, its five-year net income decline rate was 4.8%. Based on this, we believe there could be other reasons not discussed so far in this article that could be hindering the company’s growth. For example, it could be that the company has a high payout ratio or the company has allocated its capital poorly.

However, when we compared Gentherm’s growth to the industry, we found that while the company’s earnings declined, the industry saw earnings growth of 16% during the same period. That’s quite worrying.

Earnings growth is an important metric when evaluating a stock. Next, investors need to determine whether the expected earnings growth, or lack thereof, is already factored into the stock price. This will help them determine whether the stock’s future looks promising or bleak. If you’re wondering about Gentherm’s valuation, check out this metric of its price-to-earnings ratio compared to the industry.

Does Gentherm use its profits efficiently?

Gentherm does not pay regular dividends, which means that it is possible that all profits are reinvested in the company. However, this does not explain why the company’s profits have shrunk if it is retaining all profits. So there could be other explanations in this regard. For example, the company’s business could be deteriorating.

Summary

Overall, we think Gentherm has some positive attributes. However, given its high return on equity and high profit retention, we would expect the company to deliver strong earnings growth, but that is not the case here. This suggests that there may be an external threat to the company that is hindering its growth. With that in mind, we have examined the latest analyst forecasts and found that while the company has suffered earnings losses in the past, analysts expect earnings to grow in the future. For more information on the latest analyst forecasts for the company, check out this visualization of analyst forecasts for the company.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.