Is Weakness In Direcional Engenharia S.A. (BVMF:DIRR3) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

It is hard to get excited after looking at Direcional Engenharia's (BVMF:DIRR3) recent performance, when its stock has declined 12% over the past week. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Direcional Engenharia's ROE in this article.

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.

Check out our latest analysis for Direcional Engenharia

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

So, based on the above formula, the ROE for Direcional Engenharia is:

18% = R$387m ÷ R$2.1b (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. So, this means that for every R$1 of its shareholder's investments, the company generates a profit of R$0.18.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Direcional Engenharia's Earnings Growth And 18% ROE

To start with, Direcional Engenharia's ROE looks acceptable. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Probably as a result of this, Direcional Engenharia was able to see an impressive net income growth of 43% over the last five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Direcional Engenharia's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 19%.

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). Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for DIRR3? You can find out in our latest intrinsic value infographic research report.

Is Direcional Engenharia Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 65% (implying that it keeps only 35% of profits) for Direcional Engenharia suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Moreover, Direcional Engenharia 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 72% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 21%.

Summary

On the whole, we feel that Direcional Engenharia's performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.