With its stock down 9.8% over the past three months, it is easy to disregard Domain Holdings Australia (ASX:DHG). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Domain Holdings Australia's ROE in this article.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Domain Holdings Australia is:
3.6% = AU$40m ÷ AU$1.1b (Based on the trailing twelve months to June 2023).
The 'return' is the yearly profit. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.04 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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 Domain Holdings Australia's Earnings Growth And 3.6% ROE
It is hard to argue that Domain Holdings Australia's ROE is much good in and of itself. Even compared to the average industry ROE of 14%, the company's ROE is quite dismal. In spite of this, Domain Holdings Australia was able to grow its net income considerably, at a rate of 39% in the last five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Domain Holdings Australia'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 28% in the same 5-year period.
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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Domain Holdings Australia is trading on a high P/E or a low P/E, relative to its industry.
Is Domain Holdings Australia Efficiently Re-investing Its Profits?
Domain Holdings Australia's significant three-year median payout ratio of 91% (where it is retaining only 8.9% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.
Moreover, Domain Holdings Australia is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 66% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 7.1%, over the same period.
Overall, we have mixed feelings about Domain Holdings Australia. While the company has posted impressive earnings growth, its poor ROE and low earnings retention makes us doubtful if that growth could continue, if by any chance the business is faced with any sort of risk. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.