Domain Holdings Australia Limited's (ASX:DHG) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Most readers would already be aware that Domain Holdings Australia's (ASX:DHG) stock increased significantly by 14% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Domain Holdings Australia's ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Domain Holdings Australia

How Do You 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 Domain Holdings Australia is:

3.7% = AU$36m ÷ AU$951m (Based on the trailing twelve months to June 2021).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.04.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Domain Holdings Australia's Earnings Growth And 3.7% ROE

It is quite clear that Domain Holdings Australia's ROE is rather low. Even when compared to the industry average of 21%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 40% seen by Domain Holdings Australia over the last five years is not surprising. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

That being said, we compared Domain Holdings Australia's 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 1.8% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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?

With a high LTM (or last twelve month) payout ratio of 68% (implying that 32% of the profits are retained), most of Domain Holdings Australia's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely.

In addition, Domain Holdings Australia has been paying dividends over a period of four years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 64%. However, Domain Holdings Australia's ROE is predicted to rise to 9.3% despite there being no anticipated change in its payout ratio.

Conclusion

Overall, we would be extremely cautious before making any decision on Domain Holdings Australia. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. 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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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.
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