Sakae Electronics Corporation's (TYO:7567) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Sakae Electronics (TYO:7567) has had a great run on the share market with its stock up by a significant 35% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Sakae Electronics' ROE in this article.

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.

Check out our latest analysis for Sakae Electronics

How Do You Calculate Return On Equity?

ROE 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 Sakae Electronics is:

2.3% = JP¥66m ÷ JP¥2.8b (Based on the trailing twelve months to March 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ¥1 worth of shareholders' equity, the company generated ¥0.02 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Sakae Electronics' Earnings Growth And 2.3% ROE

When you first look at it, Sakae Electronics' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 6.4% either. For this reason, Sakae Electronics' five year net income decline of 8.1% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

However, when we compared Sakae Electronics' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 9.5% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Sakae Electronics fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Sakae Electronics Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 25% (that is, a retention ratio of 75%), the fact that Sakae Electronics' earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Sakae Electronics has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

Overall, we have mixed feelings about Sakae Electronics. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 4 risks we have identified for Sakae Electronics by visiting our risks dashboard for free on our platform here.

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This article by Simply Wall St is general in nature. 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.
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