It is hard to get excited after looking at Data#3's (ASX:DTL) recent performance, when its stock has declined 16% over the past three months. 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 Data#3's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Data#3

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Data#3 is:

58% = AU$41m ÷ AU$72m (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.58 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 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.

Data#3's Earnings Growth And 58% ROE

Firstly, we acknowledge that Data#3 has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 6.4% also doesn't go unnoticed by us. This probably laid the groundwork for Data#3's moderate 17% net income growth seen over the past five years.

As a next step, we compared Data#3's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 15% in the same period.

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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Data#3's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.