Has Dunelm Group plc's (LON:DNLM) Impressive Stock Performance Got Anything to Do With Its Fundamentals?
Most readers would already be aware that Dunelm Group's (LON:DNLM) stock increased significantly by 18% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Dunelm Group'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Dunelm Group
How Do You Calculate Return On Equity?
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 Dunelm Group is:
78% = UK£113m ÷ UK£144m (Based on the trailing twelve months to June 2020).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.78 in profit.
What Is The Relationship Between ROE And 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Dunelm Group's Earnings Growth And 78% ROE
To begin with, Dunelm Group has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. However, we are curious as to how the high returns still resulted in a flat growth for Dunelm Group in the past five years. We reckon that there could be some other factors at play here that's limiting 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, when we compared with the industry, which has shrunk its earnings at a rate of 0.2% in the same period, we still found Dunelm Group's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
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. 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 Dunelm Group is trading on a high P/E or a low P/E, relative to its industry.
Is Dunelm Group Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 69% (implying that the company keeps only 31% of its income) of its business to reinvest into its business), most of Dunelm Group's profits are being paid to shareholders, which explains the absence of growth in earnings.
Our latest analyst data shows that the future payout ratio of the company is expected to drop to 53% over the next three years. Regardless, the future ROE for Dunelm Group is predicted to decline to 52% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.
Summary
In total, it does look like Dunelm Group has some positive aspects to its business. 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow 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.
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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