Deluxe Family's (SHSE:600503) stock is up by a considerable 22% over the past month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study Deluxe Family'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Deluxe Family is:

2.2% = CN¥80m ÷ CN¥3.7b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.02 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Deluxe Family's Earnings Growth And 2.2% ROE

As you can see, Deluxe Family's ROE looks pretty weak. Not just that, even compared to the industry average of 3.3%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 28% seen by Deluxe Family over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 7.2% in the same 5-year period, we still found Deluxe Family's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Deluxe Family's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Deluxe Family Making Efficient Use Of Its Profits?

Deluxe Family's low three-year median payout ratio of 11% (implying that it retains the remaining 89% of its profits) comes as a surprise when you pair it with the shrinking earnings. This typically shouldn't be the case when a company is retaining most of its earnings. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Deluxe Family 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

Overall, we have mixed feelings about Deluxe Family. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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. You can see the 1 risk we have identified for Deluxe Family by visiting our risks dashboard for free on our platform here.

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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.