Should Weakness in DLF Limited's (NSE:DLF) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

DLF (NSE:DLF) has had a rough three months with its share price down 8.4%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study DLF'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for DLF

How Is ROE Calculated?

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 DLF is:

6.9% = ₹27b ÷ ₹394b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.07 in profit.

What Has ROE Got To Do With 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 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.

DLF's Earnings Growth And 6.9% ROE

As you can see, DLF's ROE looks pretty weak. Further, we noted that the company's ROE is similar to the industry average of 6.5%. However, the exceptional 26% net income growth seen by DLF over the past five years is pretty remarkable. Considering the low ROE, it is quite possible that there might also be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between DLF's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 25% in the same 5-year period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 DLF is trading on a high P/E or a low P/E, relative to its industry.

Is DLF Making Efficient Use Of Its Profits?

DLF's three-year median payout ratio is a pretty moderate 47%, meaning the company retains 53% of its income. By the looks of it, the dividend is well covered and DLF is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, DLF has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 34% over the next three years. The fact that the company's ROE is expected to rise to 10% over the same period is explained by the drop in the payout ratio.

Conclusion

In total, it does look like DLF has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. The latest industry analyst forecasts show that the company is expected to maintain 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.

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