Darden Restaurants' (NYSE:DRI) stock up by 5.9% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Darden Restaurants' ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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 Darden Restaurants is:

49% = US$1.0b ÷ US$2.1b (Based on the trailing twelve months to August 2024).

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 $0.49 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.

Darden Restaurants' Earnings Growth And 49% ROE

First thing first, we like that Darden Restaurants has an impressive ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. As a result, Darden Restaurants' exceptional 25% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Darden Restaurants' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 33% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for DRI? You can find out in our latest intrinsic value infographic research report.

Is Darden Restaurants Making Efficient Use Of Its Profits?

Darden Restaurants has a significant three-year median payout ratio of 60%, meaning the company only retains 40% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Besides, Darden Restaurants has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its 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 58%. Accordingly, forecasts suggest that Darden Restaurants' future ROE will be 49% which is again, similar to the current ROE.

Conclusion

In total, it does look like Darden Restaurants has some positive aspects to its business. Its earnings growth is decent, and the high ROE does contribute to that growth. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.