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Should Weakness in DCC plc's (LON:DCC) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

DCC (LON:DCC) has had a rough month with its share price down 3.7%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on DCC's ROE.

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.

See our latest analysis for DCC

How Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

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So, based on the above formula, the ROE for DCC is:

11% = UK£343m ÷ UK£3.1b (Based on the trailing twelve months to September 2023).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.11 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

DCC's Earnings Growth And 11% ROE

To begin with, DCC seems to have a respectable ROE. Especially when compared to the industry average of 8.9% the company's ROE looks pretty impressive. This probably laid the ground for DCC's moderate 7.5% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that DCC's reported growth was lower than the industry growth of 14% over the last few years, which is not something we like to see.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for DCC? You can find out in our latest intrinsic value infographic research report.

Is DCC Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 55% (or a retention ratio of 45%) for DCC suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, DCC 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 41% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 14%, over the same period.

Conclusion

Overall, we feel that DCC certainly does have some positive factors to consider. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.