D4t4 Solutions (LON:D4T4) has had a great run on the share market with its stock up by a significant 42% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on D4t4 Solutions’ ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
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 D4t4 Solutions is:
15% = UK£4.4m ÷ UK£29m (Based on the trailing twelve months to March 2020).
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 £0.15 in profit.
What Is The Relationship Between ROE And 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. 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.
D4t4 Solutions’ Earnings Growth And 15% ROE
At first glance, D4t4 Solutions seems to have a decent ROE. Further, the company’s ROE is similar to the industry average of 16%. This probably goes some way in explaining D4t4 Solutions’ significant 20% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. 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.
Next, on comparing D4t4 Solutions’ net income growth with the industry, we found that the company’s reported growth is similar to the industry average growth rate of 22% in the same period.
Earnings growth is a huge factor in stock valuation. 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. 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 D4t4 Solutions is trading on a high P/E or a low P/E, relative to its industry.
Is D4t4 Solutions Making Efficient Use Of Its Profits?
D4t4 Solutions’ three-year median payout ratio is a pretty moderate 27%, meaning the company retains 73% of its income. By the looks of it, the dividend is well covered and D4t4 Solutions is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.
Additionally, D4t4 Solutions has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with 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 30%. However, D4t4 Solutions’ future ROE is expected to decline to 10.0% despite there being not much change anticipated in the company’s payout ratio.
In total, we are pretty happy with D4t4 Solutions’ performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, according to the latest industry analyst forecasts, the company’s earnings are expected to shrink in the future. 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. 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.
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