Delfi Limited's (SGX:P34) Stock Is Going Strong: Is the Market Following Fundamentals?

Delfi's (SGX:P34) stock is up by a considerable 11% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Delfi's ROE.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Delfi

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 Delfi is:

11% = US$24m ÷ US$224m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. That means that for every SGD1 worth of shareholders' equity, the company generated SGD0.11 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. 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.

Delfi's Earnings Growth And 11% ROE

At first glance, Delfi seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 11%. Consequently, this likely laid the ground for the decent growth of 15% seen over the past five years by Delfi.

Next, on comparing with the industry net income growth, we found that Delfi's growth is quite high when compared to the industry average growth of 5.5% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Delfi is trading on a high P/E or a low P/E, relative to its industry.

Is Delfi Using Its Retained Earnings Effectively?

Delfi has a significant three-year median payout ratio of 55%, meaning that it is left with only 45% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Additionally, Delfi 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 52%. As a result, Delfi's ROE is not expected to change by much either, which we inferred from the analyst estimate of 8.9% for future ROE.

Summary

Overall, we are quite pleased with Delfi's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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