Shares of DiscoverIE Group plc (LON:DSCV) have weakened lately, but the financial outlook looks correct: is the market wrong?

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It’s hard to get excited after looking at the recent performance of the DiscoverIE Group (LON:DSCV), as its stock is down 25% in the past three months. But if you pay close attention, you might find that its leading financial indicators look pretty decent, which could mean the stock could potentially rise in the long run as markets generally reward more resilient long-term fundamentals. In this article, we decided to focus on the ROE of discoveryIE Group.

Return on equity or ROE is a key metric used to gauge how effectively a company’s management is using the company’s capital. In other words, it reveals the company’s success in turning shareholders’ investments into profits.

Check out our latest analysis for the DiscoverIE group

How is ROE calculated?

The ROE formula is:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the formula above, the ROE for the DiscoverIE group is:

3.3% = £9.7m ÷ £290m (based on trailing 12 months to March 2022).

The “yield” is the profit of the last twelve months. This means that for every pound of equity, the company generated a profit of 0.03 pounds.

What does ROE have to do with earnings growth?

So far we have learned that ROE is a measure of a company’s profitability. Depending on how much of those earnings the company reinvests or “keeps”, and how efficiently it does so, we are then able to gauge a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.

3.3% profit growth and ROE of the DiscoverIE Group

At first glance, discoveryIE Group’s ROE does not look very promising. We then compared the company’s ROE to the entire industry and were disappointed to see that the ROE is below the industry average of 13%. The DiscoverIE Group has still been able to record a decent growth in net profit of 6.1% over the past five years. We believe there could be other factors at play here. For example, it is possible that the management of the company has made good strategic decisions or that the company has a low payout ratio.

Then, when comparing with the net income growth of the industry, we found that the reported growth of the discoveryIE group was lower than the industry growth of 8.5% over the same period, which we don’t like to see .

LSE: DSCV Past Earnings Growth July 14, 2022

Earnings growth is an important factor in stock valuation. The investor should try to establish whether the expected growth or decline in earnings, as the case may be, is taken into account. By doing so, he will get an idea if the title is heading for clear blue waters or if swampy waters await. Has the market priced in DSCV’s future prospects? You can find out in our latest infographic research report on intrinsic value.

Is the discoveryIE group effectively using its retained earnings?

With a three-year median payout ratio of 48% (implying the company retains 52% of its earnings), it appears discoveryIE Group is effectively reinvesting to see respectable earnings growth and paying a dividend that is well covered.

Additionally, the DiscoverIE Group has paid dividends over a period of at least ten years, which means the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the company’s future payout ratio is expected to drop to 37% over the next three years. As a result, the expected drop in DiscoverIE Group’s payout rate explains the company’s expected future ROE increase to 11% over the same period.

Summary

Overall, we feel the DiscoverIE group has positive attributes. In other words, decent earnings growth supported by a high rate of reinvestment. However, we believe that this earnings growth could have been higher if the company were to improve the low ROE rate. Especially considering how the company reinvests a huge portion of its profits. That said, the latest analyst forecasts show that the company will continue to see earnings expansion. For more on the company’s future earnings growth forecast, check out this free analyst forecast report for the company to learn more.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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