Could The Market Be Wrong About Donegal Investment Group plc (ISE:DQ7A) Given Its Attractive Financial Prospects?

Donegal Investment Group (ISE:DQ7A) has had a rough three months with its share price down 7.8%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Donegal Investment Group's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Donegal Investment Group

How Do You Calculate Return On Equity?

Return on equity 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 Donegal Investment Group is:

12% = €2.1m ÷ €17m (Based on the trailing twelve months to August 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.12 in profit.

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. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Donegal Investment Group's Earnings Growth And 12% ROE

To begin with, Donegal Investment Group seems to have a respectable ROE. Especially when compared to the industry average of 8.2% the company's ROE looks pretty impressive. This probably laid the ground for Donegal Investment Group's moderate 9.2% net income growth seen over the past five years.

As a next step, we compared Donegal Investment Group's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.1%.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Donegal Investment Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Donegal Investment Group Efficiently Re-investing Its Profits?

Given that Donegal Investment Group doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Conclusion

On the whole, we feel that Donegal Investment Group's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 3 risks we have identified for Donegal Investment Group visit our risks dashboard for free.

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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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