Should Weakness in Data#3 Limited's (ASX:DTL) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 13% over the past three months, it is easy to disregard Data#3 (ASX:DTL). 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 Data#3's ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Data#3

How Is ROE Calculated?

Return on equity 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 Data#3 is:

45% = AU$24m ÷ AU$53m (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.45 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. 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

First thing first, we like that Data#3 has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 10.0% also doesn't go unnoticed by us. This likely paved the way for the modest 13% net income growth seen by Data#3 over the past five years. growth

We then compared Data#3's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 21% in the same period, which is a bit concerning.

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. 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 Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 90% (or a retention ratio of 10%) 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 73% of its profits over the next three years. However, Data#3's ROE is predicted to rise to 55% despite there being no anticipated change in its payout ratio.

Summary

On the whole, we do feel that Data#3 has some positive attributes. Its earnings growth is decent, and the high ROE does contribute to that growth. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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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