Should Weakness in Studio Dragon Corporation's (KOSDAQ:253450) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 14% over the past three months, it is easy to disregard Studio Dragon (KOSDAQ:253450). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Studio Dragon's ROE in this article.

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.

View our latest analysis for Studio Dragon

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 Studio Dragon is:

4.3% = ₩30b ÷ ₩708b (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every ₩1 worth of equity, the company was able to earn ₩0.04 in profit.

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 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.

Studio Dragon's Earnings Growth And 4.3% ROE

It is quite clear that Studio Dragon's ROE is rather low. Even compared to the average industry ROE of 7.0%, the company's ROE is quite dismal. Studio Dragon was still able to see a decent net income growth of 8.0% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

We then compared Studio Dragon's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 21% in the same 5-year period, which is a bit concerning.

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 Studio Dragon is trading on a high P/E or a low P/E, relative to its industry.

Is Studio Dragon Making Efficient Use Of Its Profits?

Given that Studio Dragon doesn't pay any regular dividends to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Conclusion

Overall, we feel that Studio Dragon certainly does have some positive factors to consider. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. 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.

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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.