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Most readers would already be aware that D2L's (TSE:DTOL) stock increased significantly by 43% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on D2L's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for D2L
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for D2L is:
10% = US$6.4m ÷ US$63m (Based on the trailing twelve months to October 2024).
The 'return' is the yearly profit. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.10 in profit.
What Is The Relationship Between ROE And 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.
D2L's Earnings Growth And 10% ROE
On the face of it, D2L's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 14% either. However, we we're pleasantly surprised to see that D2L grew its net income at a significant rate of 46% in the last five years. So, there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared D2L'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 21%.
Earnings growth is an important metric to consider when valuing a stock. 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. 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 D2L is trading on a high P/E or a low P/E, relative to its industry.