Digital Realty Trust's (NYSE:DLR) stock up by 4.6% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Particularly, we will be paying attention to Digital Realty Trust's ROE today.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Digital Realty Trust is:
2.9% = US$529m ÷ US$18b (Based on the trailing twelve months to March 2021).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.03 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 2.9% ROE
As you can see, Digital Realty Trust's ROE looks pretty weak. Not just that, even compared to the industry average of 5.1%, the company's ROE is entirely unremarkable. Digital Realty Trust was still able to see a decent net income growth of 19% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. 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 9.9%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for DLR? You can find out in our latest intrinsic value infographic research report.
Is Digital Realty Trust Making Efficient Use Of Its Profits?
Digital Realty Trust seems to be paying out most of its income as dividends judging by its three-year median payout ratio of 72%, meaning the company retains only 28% of its income. However, this is typical for REITs as they are often required by law to distribute most of their earnings. 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 69% of its profits over the next three years. Still, forecasts suggest that Digital Realty Trust's future ROE will rise to 4.3% even though the the company's payout ratio is not expected to change by much.
Overall, we feel that Digital Realty Trust certainly does have some positive factors to consider. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
If you decide to trade Digital Realty Trust, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.