Yahoo Finance Downer EDI Limited (ASX:DOW) Stock's On A Decline: Are Poor Fundamentals The Cause?
It is hard to get excited after looking at Downer EDI's (ASX:DOW) recent performance, when its stock has declined 14% over the past three months. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Specifically, we decided to study Downer EDI'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Downer EDI
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Downer EDI is:
4.8% = AU$134m ÷ AU$2.8b (Based on the trailing twelve months to December 2022).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.05 in profit.
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.
A Side By Side comparison of Downer EDI's Earnings Growth And 4.8% ROE
At first glance, Downer EDI's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 4.8%. Having said that, Downer EDI's net income growth over the past five years is more or less flat. Remember, the company's ROE is not particularly great to begin with. So that could also be one of the reasons behind the company's flat growth in earnings.
As a next step, we compared Downer EDI's performance with the industry and found thatDowner EDI's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 1.2% in the same period, which is a slower than the company.
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. Is Downer EDI fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Downer EDI Efficiently Re-investing Its Profits?
Downer EDI has a high three-year median payout ratio of 89% (or a retention ratio of 11%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.
In addition, Downer EDI 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 68% over the next three years. The fact that the company's ROE is expected to rise to 9.9% over the same period is explained by the drop in the payout ratio.
Conclusion
In total, we would have a hard think before deciding on any investment action concerning Downer EDI. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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