Dongguang Chemical Limited's (HKG:1702) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Most readers would already be aware that Dongguang Chemical's (HKG:1702) stock increased significantly by 35% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Dongguang Chemical'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 Dongguang Chemical

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 Dongguang Chemical is:

7.6% = CN¥126m ÷ CN¥1.7b (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.08.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

A Side By Side comparison of Dongguang Chemical's Earnings Growth And 7.6% ROE

At first glance, Dongguang Chemical's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 10%. Although, we can see that Dongguang Chemical saw a modest net income growth of 15% over the past five years. So, there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Dongguang Chemical's growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Dongguang Chemical fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Dongguang Chemical Making Efficient Use Of Its Profits?

Dongguang Chemical has a low three-year median payout ratio of 21%, meaning that the company retains the remaining 79% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Besides, Dongguang Chemical has been paying dividends over a period of five years. This shows that the company is committed to sharing profits with its shareholders.

Summary

On the whole, we do feel that Dongguang Chemical has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 2 risks we have identified for Dongguang Chemical 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.