It is hard to get excited after looking at China Distance Education Holdings' (NYSE:DL) recent performance, when its stock has declined 32% over the past three months. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on China Distance Education 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You 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 China Distance Education Holdings is:
9.1% = US$12m ÷ US$131m (Based on the trailing twelve months to December 2019).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.09 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learnt 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. 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.
China Distance Education Holdings' Earnings Growth And 9.1% ROE
At first glance, China Distance Education Holdings' ROE doesn't look very promising. However, its ROE is similar to the industry average of 10%, so we won't completely dismiss the company. But then again, China Distance Education Holdings' five year net income shrunk at a rate of 15%. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.
However, when we compared China Distance Education Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 China Distance Education Holdings is trading on a high P/E or a low P/E, relative to its industry.
Is China Distance Education Holdings Efficiently Re-investing Its Profits?
Because China Distance Education Holdings doesn't pay any dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Overall, we have mixed feelings about China Distance Education Holdings. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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