dotdigital Group (LON:DOTD) has had a rough week with its share price down 4.5%. 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 dotdigital Group'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.

View our latest analysis for dotdigital Group

How To 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 dotdigital Group is:

13% = UK￡12m ÷ UK￡92m (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. Another way to think of that is that for every ￡1 worth of equity, the company was able to earn ￡0.13 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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

dotdigital Group's Earnings Growth And 13% ROE

At first glance, dotdigital Group seems to have a decent ROE. On comparing with the average industry ROE of 7.6% the company's ROE looks pretty remarkable. However, for some reason, the higher returns aren't reflected in dotdigital Group's meagre five year net income growth average of 3.1%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared dotdigital Group's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 21% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for DOTD? You can find out in our latest intrinsic value infographic research report.