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It is hard to get excited after looking at Duxton Water's (ASX:D2O) recent performance, when its stock has declined 3.3% over the past month. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Duxton Water'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Duxton Water
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Duxton Water is:
3.3% = AU$6.3m ÷ AU$193m (Based on the trailing twelve months to December 2023).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.03 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Duxton Water's Earnings Growth And 3.3% ROE
It is quite clear that Duxton Water's ROE is rather low. Not just that, even compared to the industry average of 8.4%, the company's ROE is entirely unremarkable. Duxton Water was still able to see a decent net income growth of 5.9% over the past five years. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Duxton Water's growth is quite high when compared to the industry average growth of 3.6% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Duxton Water is trading on a high P/E or a low P/E, relative to its industry.