Most readers would already be aware that discoverIE Group's (LON:DSCV) stock increased significantly by 15% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to discoverIE Group's ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Do You 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 discoverIE Group is:
5.8% = UK£12m ÷ UK£207m (Based on the trailing twelve months to September 2020).
The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.06.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
discoverIE Group's Earnings Growth And 5.8% ROE
At first glance, discoverIE Group's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.8%. In spite of this, discoverIE Group was able to grow its net income considerably, at a rate of 23% in the last five years. Therefore, there could be other reasons behind this growth. 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 discoverIE Group's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 17%.
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). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if discoverIE Group is trading on a high P/E or a low P/E, relative to its industry.
Is discoverIE Group Using Its Retained Earnings Effectively?
discoverIE Group's three-year median payout ratio is a pretty moderate 48%, meaning the company retains 52% of its income. By the looks of it, the dividend is well covered and discoverIE Group is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.
Moreover, discoverIE Group is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 39% of its profits over the next three years. Still, forecasts suggest that discoverIE Group's future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.
Overall, we feel that discoverIE Group certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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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