Data#3 (ASX:DTL) has had a great run on the share market with its stock up by a significant 20% over the last week. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Data#3's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You Calculate Return On Equity?
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 Data#3 is:
45% = AU$25m ÷ AU$56m (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.45.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Data#3's Earnings Growth And 45% ROE
Firstly, we acknowledge that Data#3 has a significantly high ROE. Secondly, even when compared to the industry average of 8.3% the company's ROE is quite impressive. This probably laid the groundwork for Data#3's moderate 14% net income growth seen over the past five years.
As a next step, we compared Data#3'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 19% in the same period.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Data#3 fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Data#3 Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 91% (or a retention ratio of 9.4%) for Data#3 suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Additionally, Data#3 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 90% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 53%.
Overall, we feel that Data#3 certainly does have some positive factors to consider. As noted earlier, its earnings growth has been quite decent, and the high ROE does contribute to that growth. Still, the company invests little to almost none of its profits. This could potentially reduce the odds that the company continues to see the same level of growth in the future. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.
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