Most readers would already be aware that Data#3's (ASX:DTL) stock increased significantly by 7.2% over the past month. 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. Specifically, we decided to study Data#3's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Data#3

How Is ROE Calculated?

ROE 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:

58% = AU$43m ÷ AU$75m (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.58 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Data#3's Earnings Growth And 58% ROE

To begin with, Data#3 has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 6.4% which is quite remarkable. Probably as a result of this, Data#3 was able to see a decent net income growth of 17% over the last five years.

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 27% in the same 5-year period, which is a bit concerning.

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). This then helps them determine if the stock is placed for a bright or bleak future. What is DTL worth today? The intrinsic value infographic in our free research report helps visualize whether DTL is currently mispriced by the market.

Is Data#3 Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 91% (or a retention ratio of 8.8%) for Data#3 suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Data#3 is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 90%. As a result, Data#3's ROE is not expected to change by much either, which we inferred from the analyst estimate of 65% for future ROE.

Summary

In total, it does look like Data#3 has some positive aspects to its business. As noted earlier, its earnings growth has been quite decent, and the high ROE does contribute to that growth. Still, the company invests little to almost none of its profits. This could potentially reduce the odds that the company continues to see the same level of growth in the future. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.