Downer EDI Limited's (ASX:DOW) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Downer EDI (ASX:DOW) has had a great run on the share market with its stock up by a significant 12% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Downer EDI's ROE.

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.

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

How Is ROE Calculated?

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 Downer EDI is:

3.8% = AU$86m ÷ AU$2.2b (Based on the trailing twelve months to December 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.04.

Check out our latest analysis for Downer EDI

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.

Downer EDI's Earnings Growth And 3.8% ROE

As you can see, Downer EDI's ROE looks pretty weak. Even compared to the average industry ROE of 9.5%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 20% seen by Downer EDI was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

So, as a next step, we compared Downer EDI's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 11% over the last few years.ASX:DOW Past Earnings Growth August 13th 2025

Earnings growth is an important metric to consider when valuing a stock. 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 Downer EDI's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Story Continues

Is Downer EDI Using Its Retained Earnings Effectively?

Downer EDI'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 100% (or a retention ratio of -0.2%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Downer EDI by visiting our risks dashboard for free on our platform here.

Moreover, Downer EDI has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 62% 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 15%, over the same period.

Summary

On the whole, Downer EDI's performance is quite a big let-down. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this freereport on analyst forecasts for the company to find out more.

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.

View Comments