With its stock down 7.8% over the past three months, it is easy to disregard DCC (LON:DCC). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to DCC's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for DCC

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 DCC is:

11% = UK￡341m ÷ UK￡3.2b (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. That means that for every ￡1 worth of shareholders' equity, the company generated ￡0.11 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 DCC's Earnings Growth And 11% ROE

To start with, DCC's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 8.4%. This probably laid the ground for DCC's moderate 6.9% net income growth seen over the past five years.

We then compared DCC's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 16% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 DCC is trading on a high P/E or a low P/E, relative to its industry.

Is DCC Efficiently Re-investing Its Profits?

DCC has a significant three-year median payout ratio of 55%, meaning that it is left with only 45% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Additionally, DCC has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 42% 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

In total, it does look like DCC has some positive aspects to its business. Its earnings growth is decent, and the high ROE does contribute to that growth. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. 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.

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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.