DCC (LON:DCC) has had a rough month with its share price down 3.0%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study DCC's ROE in this article.
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 Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for DCC is:
10.0% = UK£254m ÷ UK£2.5b (Based on the trailing twelve months to March 2020).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.10 in profit.
What Is The Relationship Between ROE And 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 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 DCC's Earnings Growth And 10.0% ROE
To start with, DCC's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 4.8%. This probably laid the ground for DCC's moderate 13% net income growth seen over the past five years.
Next, on comparing with the industry net income growth, we found that DCC's growth is quite high when compared to the industry average growth of 4.4% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is DCC fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is DCC Efficiently Re-investing Its Profits?
DCC has a healthy combination of a moderate three-year median payout ratio of 49% (or a retention ratio of 51%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
Besides, DCC has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 42%. Regardless, the future ROE for DCC is predicted to rise to 13% despite there being not much change expected in its payout ratio.
Overall, we are quite pleased with DCC's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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.
This article by Simply Wall St is general in nature. 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.
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