Declining Stock and Solid Fundamentals: Is The Market Wrong About Darden Restaurants, Inc. (NYSE:DRI)?

With its stock down 2.4% over the past month, it is easy to disregard Darden Restaurants (NYSE:DRI). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Darden Restaurants' ROE today.

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.

Check out our latest analysis for Darden Restaurants

How Do You Calculate Return On Equity?

ROE 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 Darden Restaurants is:

48% = US$1.0b ÷ US$2.2b (Based on the trailing twelve months to February 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.48 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. 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. 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.

A Side By Side comparison of Darden Restaurants' Earnings Growth And 48% ROE

Firstly, we acknowledge that Darden Restaurants has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 17% which is quite remarkable. This probably laid the groundwork for Darden Restaurants' moderate 20% net income growth seen over the past five years.

As a next step, we compared Darden Restaurants' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 22% in the same 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. Is DRI fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Darden Restaurants Making Efficient Use Of Its Profits?

Darden Restaurants has a significant three-year median payout ratio of 60%, meaning that it is left with only 40% 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.

Moreover, Darden Restaurants is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 61% of its profits over the next three years. As a result, Darden Restaurants' ROE is not expected to change by much either, which we inferred from the analyst estimate of 51% for future ROE.

Summary

In total, we are pretty happy with Darden Restaurants' performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.