Generation Development Group Limited's (ASX:GDG) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Generation Development Group's (ASX:GDG) stock is up by a considerable 21% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Generation Development Group's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Generation Development Group

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Generation Development Group is:

7.6% = AU$4.5m ÷ AU$59m (Based on the trailing twelve months to June 2023).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.08 in profit.

Why Is ROE Important For 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. 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.

Generation Development Group's Earnings Growth And 7.6% ROE

On the face of it, Generation Development Group's ROE is not much to talk about. However, its ROE is similar to the industry average of 9.4%, so we won't completely dismiss the company. On the other hand, Generation Development Group reported a fairly low 3.0% net income growth over the past five years. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.

We then compared Generation Development Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 4.5% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Generation Development Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Generation Development Group Efficiently Re-investing Its Profits?

Generation Development Group's very high three-year median payout ratio of 129% suggests that the company is paying its shareholders more than what it is earning and it definitely contributes to the low earnings growth seen by the company. This is indicative of risk.

In addition, Generation Development Group has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 38% over the next three years. As a result, the expected drop in Generation Development Group's payout ratio explains the anticipated rise in the company's future ROE to 22%, over the same period.

Summary

In total, we would have a hard think before deciding on any investment action concerning Generation Development Group. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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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.