Yahoo Finance Is DFS Furniture plc's (LON:DFS) Recent Price Movement Underpinned By Its Weak Fundamentals?
With its stock down 11% over the past three months, it is easy to disregard DFS Furniture (LON:DFS). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to DFS Furniture's ROE today.
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.
Check out our latest analysis for DFS Furniture
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for DFS Furniture is:
31% = UK£89m ÷ UK£285m (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.31 in profit.
What Is The Relationship Between ROE And 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.
DFS Furniture's Earnings Growth And 31% ROE
To begin with, DFS Furniture has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 9.2% also doesn't go unnoticed by us. For this reason, DFS Furniture's five year net income decline of 29% raises the question as to why the high ROE didn't translate into earnings growth. So, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 6.7% in the same period, we found that DFS Furniture's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 DFS Furniture is trading on a high P/E or a low P/E, relative to its industry.
Is DFS Furniture Using Its Retained Earnings Effectively?
With a three-year median payout ratio as high as 131%,DFS Furniture's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Paying a dividend beyond their means is usually not viable over the long term. To know the 2 risks we have identified for DFS Furniture visit our risks dashboard for free.
Additionally, DFS Furniture has paid dividends over a period of seven years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 55% over the next three years. As a result, the expected drop in DFS Furniture's payout ratio explains the anticipated rise in the company's future ROE to 166%, over the same period.
Summary
Overall, we have mixed feelings about DFS Furniture. In spite of the high ROE, the company has failed to see growth in its earnings due to it paying out most of its profits as dividend, with almost nothing left to invest into its own business. Additionally, the latest industry analyst forecasts show that the company is expected to continue to see a similar decline in its earnings in the future as well. 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. 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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