Will Weakness in Designer Brands Inc.'s (NYSE:DBI) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 13% over the past three months, it is easy to disregard Designer Brands (NYSE:DBI). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Designer Brands' 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 Designer Brands

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Designer Brands is:

37% = US$163m ÷ US$436m (Based on the trailing twelve months to January 2023).

The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.37.

What Is The Relationship Between ROE And 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 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.

Designer Brands' Earnings Growth And 37% ROE

Firstly, we acknowledge that Designer Brands has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 23% which is quite remarkable. Probably as a result of this, Designer Brands was able to see a decent net income growth of 7.3% over the last five years.

Next, on comparing with the industry net income growth, we found that Designer Brands' reported growth was lower than the industry growth of 27% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Designer Brands''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Designer Brands Making Efficient Use Of Its Profits?

In Designer Brands' case, its respectable earnings growth can probably be explained by its low LTM (or last twelve month) payout ratio of 8.3% (or a retention ratio of 92%), which suggests that the company is investing most of its profits to grow its business.

Additionally, Designer Brands 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 is expected to rise to 12% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 24% over the same period.

Summary

Overall, we are quite pleased with Designer Brands' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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. 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.