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Domain Holdings Australia Limited's (ASX:DHG) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Domain Holdings Australia (ASX:DHG) has had a great run on the share market with its stock up by a significant 12% over the last 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. Specifically, we decided to study Domain Holdings Australia's ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Domain Holdings Australia

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Domain Holdings Australia is:

3.6% = AU$40m ÷ AU$1.1b (Based on the trailing twelve months to June 2022).

The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.04.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Domain Holdings Australia's Earnings Growth And 3.6% ROE

It is quite clear that Domain Holdings Australia's ROE is rather low. Not just that, even compared to the industry average of 16%, the company's ROE is entirely unremarkable. As a result, Domain Holdings Australia's flat earnings over the past five years doesn't come as a surprise given its lower ROE.

As a next step, we compared Domain Holdings Australia's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 0.1% in the same period.

past-earnings-growth
past-earnings-growth

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Domain Holdings Australia fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Domain Holdings Australia Making Efficient Use Of Its Profits?

Domain Holdings Australia has a very high LTM (or last twelve month) payout ratio of 102% over the last last three years, which suggests that the company is dipping into more than just its earnings to pay its dividend. The absence of growth in Domain Holdings Australia's earnings therefore, doesn't come as a surprise. Paying a dividend higher than reported profits is not a sustainable move. That's a huge risk in our books. To know the 2 risks we have identified for Domain Holdings Australia visit our risks dashboard for free.

Moreover, Domain Holdings Australia has been paying dividends for five years, which is a considerable amount of time, 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 67% over the next three years. As a result, the expected drop in Domain Holdings Australia's payout ratio explains the anticipated rise in the company's future ROE to 7.3%, over the same period.

Summary

Overall, we would be extremely cautious before making any decision on Domain Holdings Australia. Although the company has shown a fair bit of growth in earnings, yet the low ROE and the low rate of reinvestment makes us skeptical about the continuity of that growth, especially when or if the business comes to face any threats. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

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.

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