Diaceutics (LON:DXRX) has had a great run on the share market with its stock up by a significant 25% over the last three months. However, we decided to pay attention to the company’s fundamentals which don’t appear to give a clear sign about the company’s financial health. In this article, we decided to focus on Diaceutics’ ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
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 Diaceutics is:
2.0% = UK£398k ÷ UK£20m (Based on the trailing twelve months to December 2019).
The ‘return’ refers to a company’s earnings over the last year. So, this means that for every £1 of its shareholder’s investments, the company generates a profit of £0.02.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. 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.
Diaceutics’ Earnings Growth And 2.0% ROE
As you can see, Diaceutics’ ROE looks pretty weak. Even when compared to the industry average of 8.1%, the ROE figure is pretty disappointing. For this reason, Diaceutics’ five year net income decline of 4.6% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company’s earnings prospects. Such as – low earnings retention or poor allocation of capital.
That being said, we compared Diaceutics’ performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 15% in the same 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Diaceutics is trading on a high P/E or a low P/E, relative to its industry.
Is Diaceutics Making Efficient Use Of Its Profits?
Because Diaceutics doesn’t pay any dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Overall, we have mixed feelings about Diaceutics. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at current analyst estimates, we found that the company’s earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company’s fundamentals? Click here to be taken to our analyst’s forecasts page for the company.
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