Digital Realty Trust's (NYSE:DLR) stock is up by a considerable 14% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Digital Realty Trust's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Realty Trust is:
4.0% = US$717m ÷ US$18b (Based on the trailing twelve months to September 2021).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.04 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Digital Realty Trust's Earnings Growth And 4.0% ROE
At first glance, Digital Realty Trust's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 6.6%. However, the moderate 18% net income growth seen by Digital Realty Trust over the past five years is definitely a positive. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Digital Realty Trust's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.8%.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. What is DLR worth today? The intrinsic value infographic in our free research report helps visualize whether DLR is currently mispriced by the market.
Is Digital Realty Trust Efficiently Re-investing Its Profits?
Digital Realty Trust has a high three-year median payout ratio of 73%. This means that it has only 27% of its income left to reinvest into its business. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. In spite of this, the company was able to grow its earnings by a fair bit, as we saw above.
Besides, Digital Realty Trust has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 68%. However, Digital Realty Trust's ROE is predicted to rise to 5.6% despite there being no anticipated change in its payout ratio.
In total, it does look like Digital Realty Trust has some positive aspects to its business. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.