Dubai Refreshment (P.J.S.C.)'s (DFM:DRC) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Dubai Refreshment (P.J.S.C.) (DFM:DRC) has had a great run on the share market with its stock up by a significant 14% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Dubai Refreshment (P.J.S.C.)'s ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Dubai Refreshment (P.J.S.C.)

How Is ROE Calculated?

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 Dubai Refreshment (P.J.S.C.) is:

6.5% = د.إ55m ÷ د.إ852m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. That means that for every AED1 worth of shareholders' equity, the company generated AED0.06 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Dubai Refreshment (P.J.S.C.)'s Earnings Growth And 6.5% ROE

It is quite clear that Dubai Refreshment (P.J.S.C.)'s ROE is rather low. Even when compared to the industry average of 8.9%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 25% seen by Dubai Refreshment (P.J.S.C.) over the last five years is not surprising. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Dubai Refreshment (P.J.S.C.)'s performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 6.3% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Dubai Refreshment (P.J.S.C.)'s's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Dubai Refreshment (P.J.S.C.) Efficiently Re-investing Its Profits?

Dubai Refreshment (P.J.S.C.) has a high three-year median payout ratio of 95% (that is, it is retaining 5.2% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Dubai Refreshment (P.J.S.C.) by visiting our risks dashboard for free on our platform here.

In addition, Dubai Refreshment (P.J.S.C.) has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

Overall, we would be extremely cautious before making any decision on Dubai Refreshment (P.J.S.C.). Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Dubai Refreshment (P.J.S.C.)'s past profit growth, check out this visualization of past earnings, revenue and cash flows.

If you’re looking to trade Dubai Refreshment (P.J.S.C.), open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.