Can Mixed Financials Have A Negative Impact on Dongjiang Environmental Company Limited's 's (HKG:895) Current Price Momentum?

Dongjiang Environmental's (HKG:895) stock up by 3.9% over the past three months. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. In this article, we decided to focus on Dongjiang Environmental's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Dongjiang Environmental

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 Dongjiang Environmental is:

6.2% = CN¥319m ÷ CN¥5.2b (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.06.

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. 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.

A Side By Side comparison of Dongjiang Environmental's Earnings Growth And 6.2% ROE

On the face of it, Dongjiang Environmental's ROE is not much to talk about. Next, when compared to the average industry ROE of 10.0%, the company's ROE leaves us feeling even less enthusiastic. Therefore, Dongjiang Environmental's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

As a next step, we compared Dongjiang Environmental's net income growth with the industry and discovered that the industry saw an average growth of 13% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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 Dongjiang Environmental is trading on a high P/E or a low P/E, relative to its industry.

Is Dongjiang Environmental Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 31% (implying that the company keeps 69% of its income) over the last three years, Dongjiang Environmental has seen a negligible amount of growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Dongjiang Environmental 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 Dongjiang Environmental's performance. 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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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. 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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