Yahoo Finance Generation Development Group Limited's (ASX:GDG) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?
Most readers would already be aware that Generation Development Group's (ASX:GDG) stock increased significantly by 18% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Generation Development Group's ROE today.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Generation Development Group
How To Calculate Return On Equity?
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 Generation Development Group is:
7.6% = AU$4.5m ÷ AU$59m (Based on the trailing twelve months to June 2023).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.08.
What Is The Relationship Between ROE And 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 Generation Development Group's Earnings Growth And 7.6% ROE
At first glance, Generation Development Group's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 10%. Accordingly, Generation Development Group's low net income growth of 3.0% over the past five years can possibly be explained by the low ROE amongst other factors.
Next, on comparing Generation Development Group's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 3.0% over the last few years.
Earnings growth is an important metric to consider when valuing a stock. 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 Generation Development Group is trading on a high P/E or a low P/E, relative to its industry.
Is Generation Development Group Making Efficient Use Of Its Profits?
Generation Development Group has a very high three-year median payout ratio of 129%suggesting that the company's shareholders are getting paid from more than just the company's income. This is quite a risky position to be in.
Additionally, Generation Development Group has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 38% over the next three years. The fact that the company's ROE is expected to rise to 22% over the same period is explained by the drop in the payout ratio.
Conclusion
In total, we would have a hard think before deciding on any investment action concerning Generation Development Group. While no doubt its earnings growth is pretty respectable, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, specially during troubled times. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
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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.
