It’s hard to get excited after watching the recent performance of Dongyue Group (HKG: 189), as its stock has fallen 21% in the past three months. However, stock prices are usually determined by a company’s long-term finances, which in this case seem quite respectable. In this article, we decided to focus on Dongyue Group’s ROE.
Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In simple terms, it is used to assess the profitability of a company in relation to its equity.
Check out our latest analysis for Dongyue Group
How is ROE calculated?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Dongyue Group is:
17% = CN¥2.7b ÷ CN¥16b (Based on trailing twelve months to December 2021).
The “yield” is the amount earned after tax over the last twelve months. One way to conceptualize this is that for every HK$1 of share capital it has, the company has made a profit of HK$0.17.
What does ROE have to do with earnings growth?
We have already established that ROE serves as an effective profit-generating indicator for a company’s future earnings. We now need to assess how much profit the company is reinvesting or “retaining” for future growth, which then gives us an idea of the company’s growth potential. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.
A side-by-side comparison of Dongyue Group’s profit growth and ROE of 17%
For starters, Dongyue Group seems to have a respectable ROE. Especially when compared to the industry average of 10%, the company’s ROE looks quite impressive. Given the circumstances, we can’t help but wonder why Dongyue Group has seen little or no growth over the past five years. Based on this, we believe that there might be other reasons which have not been discussed so far in this article which might hinder the growth of the business. For example, the company may have a high payout ratio or the company may have misallocated capital, for example.
We then compared Dongyue Group’s net income growth with the industry and found that the company’s growth figure is lower than the industry average growth rate of 13% over the same period, which which is a little worrying.
Earnings growth is an important factor in stock valuation. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. By doing so, they will get an idea if the stock is headed for clear blue waters or if swampy waters are waiting. If you’re wondering about Dongyue Group’s valuation, check out this indicator of its price-earnings ratio, relative to its sector.
Does the Dongyue Group effectively reinvest its profits?
Despite a three-year normal median payout ratio of 31% (or a retention rate of 69%), Dongyue Group has not experienced strong earnings growth. So there could be another explanation for this. For example, the company’s business may deteriorate.
Additionally, the Dongyue 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 or no profit growth. Looking at current analyst consensus data, we can see that the company’s future payout ratio is expected to reach 38% over the next three years. However, the company’s ROE is not expected to change much despite the higher expected payout ratio.
All in all, it seems that the Dongyue Group has some positive aspects in its business. However, we are disappointed to see a lack of earnings growth, even despite a high ROE and high reinvestment rate. We believe there could be external factors that could negatively impact the business. That said, looking at current analyst estimates, we found that the company’s earnings are expected to accelerate. For more on the company’s future earnings growth forecast, check out this free analyst forecast report for the company to learn more.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.