Are Strong Financial Prospects The Force That Is Driving The Momentum In dotdigital Group Plc's LON:DOTD) Stock?

dotdigital Group's (LON:DOTD) stock is up by a considerable 24% over the past month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to dotdigital Group's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for dotdigital Group

How Do You Calculate Return On Equity?

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 dotdigital Group is:

17% = UK£12m ÷ UK£69m (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.17 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

dotdigital Group's Earnings Growth And 17% ROE

To begin with, dotdigital Group seems to have a respectable ROE. Especially when compared to the industry average of 7.5% the company's ROE looks pretty impressive. Probably as a result of this, dotdigital Group was able to see a decent growth of 13% over the last five years.

Next, on comparing with the industry net income growth, we found that dotdigital Group's growth is quite high when compared to the industry average growth of 9.1% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 dotdigital Group is trading on a high P/E or a low P/E, relative to its industry.

Is dotdigital Group Making Efficient Use Of Its Profits?

In dotdigital Group's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 22% (or a retention ratio of 78%), which suggests that the company is investing most of its profits to grow its business.

Moreover, dotdigital Group is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 23%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 15%.

Summary

In total, we are pretty happy with dotdigital Group's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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

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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here