Dongguan Development (Holdings)'s (SZSE:000828) stock is up by a considerable 20% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Dongguan Development (Holdings)'s ROE today.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Dongguan Development (Holdings)

How To Calculate Return On Equity?

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 Dongguan Development (Holdings) is:

5.4% = CN¥853m ÷ CN¥16b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. That means that for every CN¥1 worth of shareholders' equity, the company generated CN¥0.05 in profit.

What Is The Relationship Between ROE And 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

Dongguan Development (Holdings)'s Earnings Growth And 5.4% ROE

At first glance, Dongguan Development (Holdings)'s ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 5.6%, we may spare it some thought. But Dongguan Development (Holdings) saw a five year net income decline of 5.4% over the past five years. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.

So, as a next step, we compared Dongguan Development (Holdings)'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 3.8% over the last few years.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Dongguan Development (Holdings) fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Dongguan Development (Holdings) Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 32% (where it is retaining 68% of its profits), Dongguan Development (Holdings) has seen a decline in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Dongguan Development (Holdings) 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

In total, we're a bit ambivalent about Dongguan Development (Holdings)'s performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 5 risks we have identified for Dongguan Development (Holdings).

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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.