Driver Group plc (LON:DRV) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

By
Simply Wall St
Published
March 04, 2021
AIM:DRV
Source: Shutterstock

Driver Group (LON:DRV) has had a rough three months with its share price down 7.3%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Driver Group's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Driver Group

How Do You Calculate Return On Equity?

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 Driver Group is:

6.6% = UK£1.3m ÷ UK£20m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.07 in profit.

Why Is ROE Important For 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.

Driver Group's Earnings Growth And 6.6% ROE

When you first look at it, Driver Group's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 11% either. However, we we're pleasantly surprised to see that Driver Group grew its net income at a significant rate of 57% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Driver Group'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 21%.

past-earnings-growth
AIM:DRV Past Earnings Growth March 5th 2021

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Driver Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Driver Group Making Efficient Use Of Its Profits?

Driver Group's three-year median payout ratio to shareholders is 22%, which is quite low. This implies that the company is retaining 78% of its profits. So it looks like Driver Group is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, Driver Group has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders.

Conclusion

Overall, we feel that Driver Group certainly does have some positive factors to consider. 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. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 5 risks we have identified for Driver Group by visiting our risks dashboard for free on our platform here.

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