Is Dis-Chem Pharmacies Limited's (JSE:DCP) Recent Stock Performance Tethered To Its Strong Fundamentals?

Dis-Chem Pharmacies (JSE:DCP) has had a great run on the share market with its stock up by a significant 16% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Dis-Chem Pharmacies' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Dis-Chem Pharmacies

How To 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 Dis-Chem Pharmacies is:

22% = R923m ÷ R4.2b (Based on the trailing twelve months to August 2023).

The 'return' is the yearly profit. Another way to think of that is that for every ZAR1 worth of equity, the company was able to earn ZAR0.22 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Dis-Chem Pharmacies' Earnings Growth And 22% ROE

To start with, Dis-Chem Pharmacies' ROE looks acceptable. Especially when compared to the industry average of 18% the company's ROE looks pretty impressive. This probably laid the ground for Dis-Chem Pharmacies' moderate 11% net income growth seen over the past five years.

We then performed a comparison between Dis-Chem Pharmacies' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 12% 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. If you're wondering about Dis-Chem Pharmacies''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Dis-Chem Pharmacies Using Its Retained Earnings Effectively?

Dis-Chem Pharmacies has a healthy combination of a moderate three-year median payout ratio of 40% (or a retention ratio of 60%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Additionally, Dis-Chem Pharmacies has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 42%. Accordingly, forecasts suggest that Dis-Chem Pharmacies' future ROE will be 26% which is again, similar to the current ROE.

Conclusion

On the whole, we feel that Dis-Chem Pharmacies' performance has been quite good. 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 substantial growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.