Duty Free International Limited's (SGX:5SO) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?

Duty Free International's (SGX:5SO) stock is up by a considerable 17% over the past week. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Duty Free International's ROE.

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.

See our latest analysis for Duty Free International

How Is ROE Calculated?

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 Duty Free International is:

3.1% = RM11m ÷ RM348m (Based on the trailing twelve months to May 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.03 in profit.

What Is The Relationship Between ROE And 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.

Duty Free International's Earnings Growth And 3.1% ROE

It is hard to argue that Duty Free International's ROE is much good in and of itself. Even when compared to the industry average of 16%, the ROE figure is pretty disappointing. Thus, the low net income growth of 2.9% seen by Duty Free International over the past five years could probably be the result of it having a lower ROE.

As a next step, we compared Duty Free International's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 21% in the same period.

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

Is Duty Free International Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 73% (or a retention ratio of 27%), most of Duty Free International's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

In addition, Duty Free International has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

Overall, we would be extremely cautious before making any decision on Duty Free International. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. In brief, we think the company is risky and investors should think twice before making any final judgement on this company. Our risks dashboard would have the 4 risks we have identified for Duty Free International.

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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.