The one-year decline in earnings for Digital Arts TSE:2326) isn't encouraging, but shareholders are still up 43% over that period

Passive investing in index funds can generate returns that roughly match the overall market. But investors can boost returns by picking market-beating companies to own shares in. For example, the Digital Arts Inc. (TSE:2326) share price is up 42% in the last 1 year, clearly besting the market return of around 21% (not including dividends). So that should have shareholders smiling. Having said that, the longer term returns aren't so impressive, with stock gaining just 29% in three years.

While the stock has fallen 8.4% this week, it's worth focusing on the longer term and seeing if the stocks historical returns have been driven by the underlying fundamentals.

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While the efficient markets hypothesis continues to be taught by some, it has been proven that markets are over-reactive dynamic systems, and investors are not always rational. One flawed but reasonable way to assess how sentiment around a company has changed is to compare the earnings per share (EPS) with the share price.

Over the last twelve months, Digital Arts actually shrank its EPS by 26%.

So we don't think that investors are paying too much attention to EPS. Since the change in EPS doesn't seem to correlate with the change in share price, it's worth taking a look at other metrics.

We are skeptical of the suggestion that the 1.2% dividend yield would entice buyers to the stock. Digital Arts' revenue actually dropped 11% over last year. So the fundamental metrics don't provide an obvious explanation for the share price gain.

The image below shows how earnings and revenue have tracked over time (if you click on the image you can see greater detail).

Balance sheet strength is crucial. It might be well worthwhile taking a look at our free report on how its financial position has changed over time.

A Different Perspective

It's good to see that Digital Arts has rewarded shareholders with a total shareholder return of 43% in the last twelve months. That's including the dividend. There's no doubt those recent returns are much better than the TSR loss of 1.7% per year over five years. This makes us a little wary, but the business might have turned around its fortunes. While it is well worth considering the different impacts that market conditions can have on the share price, there are other factors that are even more important. For example, we've discovered 1 warning sign for Digital Arts that you should be aware of before investing here.

We will like Digital Arts better if we see some big insider buys. While we wait, check out this free list of undervalued stocks (mostly small caps) with considerable, recent, insider buying.

Please note, the market returns quoted in this article reflect the market weighted average returns of stocks that currently trade on Japanese exchanges.

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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.