1&1 Drillisch AG's (ETR:DRI) Stock Is Going Strong: Have Financials A Role To Play?

1&1 Drillisch (ETR:DRI) has had a great run on the share market with its stock up by a significant 25% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study 1&1 Drillisch's ROE in this article.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for 1&1 Drillisch

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 1&1 Drillisch is:

7.1% = €346m ÷ €4.9b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.07.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 1&1 Drillisch's Earnings Growth And 7.1% ROE

On the face of it, 1&1 Drillisch's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 9.5%. However, the moderate 12% net income growth seen by 1&1 Drillisch over the past five years is definitely a positive. So, the growth in the company's earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared 1&1 Drillisch'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 7.2%.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 1&1 Drillisch is trading on a high P/E or a low P/E, relative to its industry.

Is 1&1 Drillisch Efficiently Re-investing Its Profits?

1&1 Drillisch's three-year median payout ratio to shareholders is 2.4% (implying that it retains 98% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, 1&1 Drillisch is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 6.9% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 4.8% over the same period.

Summary

In total, it does look like 1&1 Drillisch has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. 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. 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.

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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.
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