With its stock down 14% over the past month, it is easy to disregard Daoming Optics&ChemicalLtd (SZSE:002632). We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Daoming Optics&ChemicalLtd's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Daoming Optics&ChemicalLtd is:

7.3% = CN¥166m ÷ CN¥2.3b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.07 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned 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. 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 Daoming Optics&ChemicalLtd's Earnings Growth And 7.3% ROE

When you first look at it, Daoming Optics&ChemicalLtd's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 6.4%, so we won't completely dismiss the company. On the other hand, Daoming Optics&ChemicalLtd reported a fairly low 3.0% net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. So this could also be one of the reasons behind the company's low growth in earnings.

Next, on comparing with the industry net income growth, we found that Daoming Optics&ChemicalLtd's reported growth was lower than the industry growth of 7.8% over the last few years, which is not something we like to see.

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. If you're wondering about Daoming Optics&ChemicalLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Daoming Optics&ChemicalLtd Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 85% (that is, the company retains only 15% of its income) over the past three years for Daoming Optics&ChemicalLtd suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

In addition, Daoming Optics&ChemicalLtd 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 Daoming Optics&ChemicalLtd. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. 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 3 risks we have identified for Daoming Optics&ChemicalLtd.

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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.

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