Driver Group plc's (LON:DRV) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Unlock stock picks and a broker-level newsfeed that powers Wall Street.

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

Sat, Dec 16, 2023, 12:55 AM 4 min read

Most readers would already be aware that Driver Group's (LON:DRV) stock increased significantly by 26% over the past month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study Driver Group's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Driver Group

How Is ROE Calculated?

Return on equity 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 Driver Group is:

0.8% = UK£125k ÷ UK£16m (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.01 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Driver Group's Earnings Growth And 0.8% ROE

It is hard to argue that Driver Group's ROE is much good in and of itself. Not just that, even compared to the industry average of 11%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 56% seen by Driver Group was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

As a next step, we compared Driver Group's performance with the industry and found thatDriver Group's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 1.7% in the same period, which is a slower than the company.

past-earnings-growth — AIM:DRV Past Earnings Growth December 16th 2023

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. Doing so will help them establish if the stock's future looks promising or ominous. 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 Driver Group is trading on a high P/E or a low P/E, relative to its industry.

Is Driver Group Making Efficient Use Of Its Profits?

Driver Group's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 61% (or a retention ratio of 39%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 3 risks we have identified for Driver Group by visiting our risks dashboard for free on our platform here.

Additionally, Driver Group 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.

Conclusion

On the whole, Driver Group's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Driver Group's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.