DistIT AB (publ)'s (STO:DIST) Stock Is Going Strong: Have Financials A Role To Play?

DistIT's (STO:DIST) stock is up by a considerable 55% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study DistIT'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for DistIT

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 DistIT is:

12% = kr50m ÷ kr427m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. So, this means that for every SEK1 of its shareholder's investments, the company generates a profit of SEK0.12.

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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

DistIT's Earnings Growth And 12% ROE

To begin with, DistIT seems to have a respectable ROE. Even when compared to the industry average of 12% the company's ROE looks quite decent. As you might expect, the 7.5% net income decline reported by DistIT is a bit of a surprise. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

So, as a next step, we compared DistIT's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 10% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 DistIT is trading on a high P/E or a low P/E, relative to its industry.

Is DistIT Making Efficient Use Of Its Profits?

While the company did payout a portion of its dividend in the past, it currently doesn't pay a dividend. This implies that potentially all of its profits are being reinvested in the business.

Our latest analyst data shows that the future payout ratio of the company is expected to drop to 18% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 17%, over the same period.

Conclusion

On the whole, we do feel that DistIT has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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