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Diversified Royalty (TSE:DIV) has had a great run on the share market with its stock up by a significant 10% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Diversified Royalty's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Diversified Royalty
How To Calculate Return On Equity?
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 Diversified Royalty is:
14% = CA$28m ÷ CA$199m (Based on the trailing twelve months to September 2022).
The 'return' refers to a company's earnings over the last year. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.14.
What Has ROE Got To Do With 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 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.
Diversified Royalty's Earnings Growth And 14% ROE
At first glance, Diversified Royalty seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 18% does temper our expectations. Diversified Royalty was still able to see a decent net income growth of 15% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the fairly high earnings growth seen by the company.
We then performed a comparison between Diversified Royalty's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 17% in the same period.