Most readers would already be aware that Dave's (NASDAQ:DAVE) stock increased significantly by 24% over the past month. 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 Dave's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Dave

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 Dave is:

20% = US$29m ÷ US$142m (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.20 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Dave's Earnings Growth And 20% ROE

To start with, Dave's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 14%. For this reason, Dave's five year net income decline of 21% raises the question as to why the high ROE didn't translate into earnings growth. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

However, when we compared Dave's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 20% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for DAVE? You can find out in our latest intrinsic value infographic research report.