Downer EDI's (ASX:DOW) stock is up by 4.9% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. Specifically, we decided to study Downer EDI's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
The formula for ROEis:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Downer EDI is:
6.7% = AU$149m ÷ AU$2.2b (Based on the trailing twelve months to June 2025).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.07 in profit.
Check out our latest analysis for Downer EDI
Why Is ROE Important For 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. 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.
Downer EDI's Earnings Growth And 6.7% ROE
On the face of it, Downer EDI's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 6.7%. Having said that, Downer EDI's net income growth over the past five years is more or less flat. Remember, the company's ROE is not particularly great to begin with. So that could also be one of the reasons behind the company's flat growth in earnings.
Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 10% over the last few years.
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. 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 Downer EDI is trading on a high P/E or a low P/E , relative to its industry.
Is Downer EDI Making Efficient Use Of Its Profits?
Downer EDI's very high three-year median payout ratio of 112% suggests that the company is paying its shareholders more than what it is earning. The absence in growth is therefore not surprising. Its usually very hard to sustain dividend payments that are higher than reported profits. This is indicative of risk. You can see the 2 risks we have identified for Downer EDI by visiting our risks dashboardfor free on our platform here.
Additionally, Downer EDI has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 63% over the next three years. As a result, the expected drop in Downer EDI's payout ratio explains the anticipated rise in the company's future ROE to 16%, over the same period.
Conclusion
On the whole, Downer EDI's performance is quite a big let-down. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.
