discoverIE Group's (LON:DSCV) stock is up by a considerable 22% 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. Specifically, we decided to study discoverIE Group's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for discoverIE Group

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 discoverIE Group is:

5.7% = UK£12m ÷ UK£209m (Based on the trailing twelve months to March 2021).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.06 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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 discoverIE Group's Earnings Growth And 5.7% ROE

When you first look at it, discoverIE Group's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 11% either. In spite of this, discoverIE Group was able to grow its net income considerably, at a rate of 20% 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 discoverIE Group'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 3.6%.

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. Is discoverIE Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is discoverIE Group Making Efficient Use Of Its Profits?

discoverIE Group has a three-year median payout ratio of 48% (where it is retaining 52% of its income) which is not too low or not too high. So it seems that discoverIE Group is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, discoverIE Group 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 37% over the next three years. As a result, the expected drop in discoverIE Group's payout ratio explains the anticipated rise in the company's future ROE to 13%, over the same period.

Summary

On the whole, we do feel that discoverIE Group has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.