Is Tein, Inc.'s(TYO:7217) Recent Stock Performance Tethered To Its Strong Fundamentals?

Most readers would already be aware that Tein's (TYO:7217) stock increased significantly by 52% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Tein's 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Tein

How Is ROE Calculated?

Return on equity 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 Tein is:

15% = JP¥598m ÷ JP¥3.9b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ¥1 of shareholders' capital it has, the company made ¥0.15 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. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Tein's Earnings Growth And 15% ROE

At first glance, Tein seems to have a decent ROE. Especially when compared to the industry average of 4.3% the company's ROE looks pretty impressive. This probably laid the ground for Tein's significant 31% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

Given that the industry shrunk its earnings at a rate of 2.5% in the same period, the net income growth of the company is quite impressive.

Earnings growth is an important metric to consider when valuing a stock. 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. 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 Tein is trading on a high P/E or a low P/E, relative to its industry.

Is Tein Using Its Retained Earnings Effectively?

Tein's three-year median payout ratio to shareholders is 8.8%, which is quite low. This implies that the company is retaining 91% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Moreover, Tein is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

Overall, we are quite pleased with Tein's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. To know the 3 risks we have identified for Tein visit our risks dashboard for free.

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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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