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Descartes Systems Group (TSE:DSG) has had a great run on the share market with its stock up by a significant 14% over the last 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 Descartes Systems Group's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Descartes Systems Group
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 Descartes Systems Group is:
10% = US$138m ÷ US$1.4b (Based on the trailing twelve months to October 2024).
The 'return' refers to a company's earnings over the last year. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.10 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Descartes Systems Group's Earnings Growth And 10% ROE
On the face of it, Descartes Systems Group's ROE is not much to talk about. 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 14%. In spite of this, Descartes Systems Group was able to grow its net income considerably, at a rate of 25% in the last five years. So, there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
We then performed a comparison between Descartes Systems Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 30% in the same 5-year period.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Descartes Systems Group is trading on a high P/E or a low P/E, relative to its industry.