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Delfi (SGX:P34) has had a rough three months with its share price down 21%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Delfi's ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Delfi is:
12% = US$28m ÷ US$228m (Based on the trailing twelve months to December 2019).
The 'return' is the yearly profit. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.12 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Delfi's Earnings Growth And 12% ROE
At first glance, Delfi seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 7.9%. Despite this, Delfi's five year net income growth was quite flat over the past five years. 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. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Next, on comparing with the industry net income growth, we found that Delfi's reported growth was a little less than the industry growth of0.4% 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. 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 P34? You can find out in our latest intrinsic value infographic research report.
Is Delfi Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 51% (implying that the company keeps only 49% of its income) of its business to reinvest into its business), most of Delfi's profits are being paid to shareholders, which explains the absence of growth in earnings.
In addition, Delfi has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 50%. Accordingly, forecasts suggest that Delfi's future ROE will be 11% which is again, similar to the current ROE.
Overall, we feel that Delfi certainly does have some positive factors to consider. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. Moreover, after studying current analyst estimates, we discovered that the company's earnings are expected to continue to shrink in the future. 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.
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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. Thank you for reading.