Drax Group plc's (LON:DRX) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

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editorial-team@simplywallst.com (Simply Wall St)

Thu, Feb 27, 2025, 11:14 PM 4 min read

It is hard to get excited after looking at Drax Group's (LON:DRX) recent performance, when its stock has declined 7.3% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Drax Group's 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Drax Group

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 Drax Group is:

25% = UK£526m ÷ UK£2.1b (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.25 in profit.

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. 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 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.

A Side By Side comparison of Drax Group's Earnings Growth And 25% ROE

To begin with, Drax Group has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 8.5% which is quite remarkable. As a result, Drax Group's exceptional 66% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Drax Group's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 25% in the same 5-year period.

past-earnings-growth — LSE:DRX Past Earnings Growth February 28th 2025

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Drax Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Drax Group Using Its Retained Earnings Effectively?

Drax Group's three-year median payout ratio is a pretty moderate 42%, meaning the company retains 58% of its income. By the looks of it, the dividend is well covered and Drax Group is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Moreover, Drax Group 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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 59% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 10%, over the same period.

Summary

In total, we are pretty happy with Drax Group's 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 substantial 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 latest analysts predictions for the company, check out this visualization of analyst forecasts 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.