Is Digital Arts Inc.'s (TSE:2326) Latest Stock Performance A Reflection Of Its Financial Health?

Digital Arts' (TSE:2326) stock is up by a considerable 42% over the past 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 Digital Arts' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Digital Arts

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 Digital Arts is:

27% = JP¥4.4b ÷ JP¥16b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. Another way to think of that is that for every ¥1 worth of equity, the company was able to earn ¥0.27 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.

Digital Arts' Earnings Growth And 27% ROE

To begin with, Digital Arts has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. This probably laid the groundwork for Digital Arts' moderate 18% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Digital Arts' growth is quite high when compared to the industry average growth of 12% 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. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 Digital Arts is trading on a high P/E or a low P/E, relative to its industry.

Is Digital Arts Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 34% (implying that the company retains 66% of its profits), it seems that Digital Arts is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Digital Arts 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.

Conclusion

Overall, we are quite pleased with Digital Arts' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.