Are Dong-A Socio Holdings Co., Ltd.'s (KRX:000640) Mixed Financials Driving The Negative Sentiment?

It is hard to get excited after looking at Dong-A Socio Holdings' (KRX:000640) recent performance, when its stock has declined 17% over the past three months. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Dong-A Socio Holdings' ROE.

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.

Check out our latest analysis for Dong-A Socio Holdings

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Dong-A Socio Holdings is:

3.3% = ₩25b ÷ ₩754b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₩1 of shareholders' capital it has, the company made ₩0.03 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Dong-A Socio Holdings' Earnings Growth And 3.3% ROE

It is quite clear that Dong-A Socio Holdings' ROE is rather low. Not just that, even compared to the industry average of 7.8%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 43% seen by Dong-A Socio Holdings was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Dong-A Socio Holdings' 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 12% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Dong-A Socio Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Dong-A Socio Holdings Making Efficient Use Of Its Profits?

When we piece together Dong-A Socio Holdings' low three-year median payout ratio of 21% (where it is retaining 79% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Moreover, Dong-A Socio Holdings has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 12% over the next three years. The fact that the company's ROE is expected to rise to 6.3% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, we feel that the performance shown by Dong-A Socio Holdings can be open to many interpretations. 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. You can see the 3 risks we have identified for Dong-A Socio Holdings 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. 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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