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Can Domain Holdings Australia Limited's (ASX:DHG) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

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Domain Holdings Australia's (ASX:DHG) stock is up by a considerable 6.5% over the past month. 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. 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.

See our latest analysis for Domain Holdings Australia

How To 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 Domain Holdings Australia is:

3.7% = AU$36m ÷ AU$951m (Based on the trailing twelve months to June 2021).

The 'return' is the profit 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$0.04.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

A Side By Side comparison of Domain Holdings Australia's Earnings Growth And 3.7% ROE

As you can see, Domain Holdings Australia's ROE looks pretty weak. Even when compared to the industry average of 21%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 40% seen by Domain Holdings Australia over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Domain Holdings Australia's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 1.8% in the same period.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Domain Holdings Australia is trading on a high P/E or a low P/E, relative to its industry.

Is Domain Holdings Australia Making Efficient Use Of Its Profits?

With a high LTM (or last twelve month) payout ratio of 68% (implying that 32% of the profits are retained), most of Domain Holdings Australia's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely.

Moreover, Domain Holdings Australia has been paying dividends for four years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 64%. Regardless, the future ROE for Domain Holdings Australia is predicted to rise to 9.3% despite there being not much change expected in its payout ratio.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Domain Holdings Australia. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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