Should Weakness in DoubleUGames Co., Ltd.'s (KRX:192080) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

DoubleUGames (KRX:192080) has had a rough week with its share price down 10%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study DoubleUGames' ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

AI is about to change healthcare. These 20 stocks are working on everything from early diagnostics to drug discovery. The best part - they are all under $10bn in marketcap - there is still time to get in early.

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for DoubleUGames is:

16% = ₩243b ÷ ₩1.6t (Based on the trailing twelve months to December 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ₩1 worth of shareholders' equity, the company generated ₩0.16 in profit.

View our latest analysis for DoubleUGames

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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 DoubleUGames' Earnings Growth And 16% ROE

At first glance, DoubleUGames seems to have a decent ROE. On comparing with the average industry ROE of 6.9% the company's ROE looks pretty remarkable. Needless to say, we are quite surprised to see that DoubleUGames' net income shrunk at a rate of 2.1% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.

So, as a next step, we compared DoubleUGames' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 42% over the last few years.

Earnings growth is a huge factor in stock valuation. 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 DoubleUGames is trading on a high P/E or a low P/E, relative to its industry.

Is DoubleUGames Using Its Retained Earnings Effectively?

DoubleUGames' low three-year median payout ratio of 10% (or a retention ratio of 90%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

In addition, DoubleUGames has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 17% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Summary

On the whole, we do feel that DoubleUGames has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.