It is hard to get excited after looking at Duolingo's (NASDAQ:DUOL) recent performance, when its stock has declined 16% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Duolingo's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How To 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 Duolingo is:

6.4% = US$46m ÷ US$711m (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.06 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. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Duolingo's Earnings Growth And 6.4% ROE

On the face of it, Duolingo's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 14% either. Duolingo was still able to see a decent net income growth of 19% over the past five years. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Duolingo'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 19% 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. Is Duolingo fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Duolingo Making Efficient Use Of Its Profits?

Duolingo doesn't pay any regular dividends, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.

Summary

On the whole, we do feel that Duolingo has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

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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.

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