Are Strong Financial Prospects The Force That Is Driving The Momentum In DFS Furniture plc's LON:DFS) Stock?

DFS Furniture (LON:DFS) has had a great run on the share market with its stock up by a significant 17% over the last month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on DFS Furniture's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for DFS Furniture

How To Calculate Return On Equity?

Return on equity 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 DFS Furniture is:

9.7% = UK£23m ÷ UK£237m (Based on the trailing twelve months to June 2023).

The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.10 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

DFS Furniture's Earnings Growth And 9.7% ROE

At first glance, DFS Furniture seems to have a decent ROE. Even so, when compared with the average industry ROE of 15%, we aren't very excited. That being the case, the significant five-year 26% net income growth reported by DFS Furniture comes as a pleasant surprise. We believe that there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the high earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that DFS Furniture's growth is quite high when compared to the industry average growth of 19% in the same period, which is great to see.

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). Doing so will help them establish if the stock's future looks promising or ominous. 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 DFS Furniture is trading on a high P/E or a low P/E, relative to its industry.

Is DFS Furniture Using Its Retained Earnings Effectively?

The three-year median payout ratio for DFS Furniture is 42%, which is moderately low. The company is retaining the remaining 58%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like DFS Furniture is reinvesting its earnings efficiently.

Besides, DFS Furniture has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 42%. Still, forecasts suggest that DFS Furniture's future ROE will rise to 14% even though the the company's payout ratio is not expected to change by much.

Summary

In total, we are pretty happy with DFS Furniture's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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. 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.