With its stock down 5.0% over the past week, it is easy to disregard Digital Realty Trust (NYSE:DLR). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Digital Realty Trust's ROE today.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Digital Realty Trust is:
7.8% = US$1.4b ÷ US$18b (Based on the trailing twelve months to March 2022).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.08.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Digital Realty Trust's Earnings Growth And 7.8% ROE
At first glance, Digital Realty Trust's ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 6.5% doesn't go unnoticed by us. Especially when you consider Digital Realty Trust's exceptional 36% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Therefore, the growth in earnings could also be the result of other factors. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Digital Realty Trust's growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.
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. If you're wondering about Digital Realty Trust's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Digital Realty Trust Efficiently Re-investing Its Profits?
Digital Realty Trust has a very high three-year median payout ratio of 76%. This means that it has only 24% of its income left to reinvest into its business. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. Regardless, this hasn't hampered its ability to grow as we saw earlier.
Additionally, Digital Realty Trust has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. 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 67%. Regardless, Digital Realty Trust's ROE is speculated to decline to 4.7% despite there being no anticipated change in its payout ratio.
In total, it does look like Digital Realty Trust has some positive aspects to its business. Namely, its significant earnings growth, to which its moderate rate of return likely contributed. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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.