Most readers would already be aware that Ducon Infratechnolgies' (NSE:DUCON) stock increased significantly by 150% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Ducon Infratechnolgies' ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Ducon Infratechnolgies is:
0.5% = ₹8.0m ÷ ₹1.5b (Based on the trailing twelve months to September 2021).
The 'return' is the amount earned after tax 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 ₹0.01 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. 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 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.
Ducon Infratechnolgies' Earnings Growth And 0.5% ROE
As you can see, Ducon Infratechnolgies' ROE looks pretty weak. Even when compared to the industry average of 12%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 13% seen by Ducon Infratechnolgies over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.
That being said, we compared Ducon Infratechnolgies' 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 14% 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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Ducon Infratechnolgies is trading on a high P/E or a low P/E, relative to its industry.
Is Ducon Infratechnolgies Using Its Retained Earnings Effectively?
Ducon Infratechnolgies doesn't pay any dividend, meaning that potentially all of its profits are being reinvested in the business, which doesn't explain why the company's earnings have shrunk if it is retaining all of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
In total, we're a bit ambivalent about Ducon Infratechnolgies' performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 4 risks we have identified for Ducon Infratechnolgies.
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.