Are Strong Financial Prospects The Force That Is Driving The Momentum In ADF Group Inc.'s TSE:DRX) Stock?
Most readers would already be aware that ADF Group's (TSE:DRX) stock increased significantly by 24% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to ADF 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for ADF Group
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 ADF Group is:
15% = CA$21m ÷ CA$140m (Based on the trailing twelve months to July 2023).
The 'return' is the yearly profit. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.15.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
ADF Group's Earnings Growth And 15% ROE
To begin with, ADF Group seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 8.2%. This probably laid the ground for ADF Group's significant 61% net income growth seen over the past five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared ADF 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 28%.
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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 ADF Group is trading on a high P/E or a low P/E, relative to its industry.
Is ADF Group Using Its Retained Earnings Effectively?
ADF Group's three-year median payout ratio to shareholders is 5.8%, which is quite low. This implies that the company is retaining 94% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Moreover, ADF 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.
Conclusion
In total, we are pretty happy with ADF Group's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings.
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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.
