Is Weakness In Napco Security Technologies, Inc. (NASDAQ:NSSC) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

It is hard to get excited after looking at Napco Security Technologies' (NASDAQ:NSSC) recent performance, when its stock has declined 18% over the past week. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Napco Security Technologies' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Napco Security Technologies

How Do You Calculate Return On Equity?

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 Napco Security Technologies is:

28% = US$47m ÷ US$168m (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.28 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Napco Security Technologies' Earnings Growth And 28% ROE

First thing first, we like that Napco Security Technologies has an impressive ROE. Secondly, even when compared to the industry average of 10% the company's ROE is quite impressive. Under the circumstances, Napco Security Technologies' considerable five year net income growth of 30% was to be expected.

Next, on comparing with the industry net income growth, we found that Napco Security Technologies' growth is quite high when compared to the industry average growth of 15% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Napco Security Technologies''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Napco Security Technologies Efficiently Re-investing Its Profits?

Napco Security Technologies has a really low three-year median payout ratio of 17%, meaning that it has the remaining 83% left over to reinvest into its business. So it looks like Napco Security Technologies is reinvesting profits heavily to grow its business, which shows in its earnings growth.

While Napco Security Technologies has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Summary

On the whole, we feel that Napco Security Technologies' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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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.