Declining Stock and Solid Fundamentals: Is The Market Wrong About Sumitomo Electric Industries, Ltd. (TSE:5802)?

Sumitomo Electric Industries (TSE:5802) has had a rough three months with its share price down 8.8%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Sumitomo Electric Industries' ROE.

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 Sumitomo Electric Industries

How Do You 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 Sumitomo Electric Industries is:

8.3% = JP¥211b ÷ JP¥2.5t (Based on the trailing twelve months to December 2024).

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 ¥0.08 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. 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 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.

Sumitomo Electric Industries' Earnings Growth And 8.3% ROE

When you first look at it, Sumitomo Electric Industries' ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 6.0%, is definitely interesting. Particularly, the substantial 26% net income growth seen by Sumitomo Electric Industries over the past five years is impressive . That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. Therefore, the growth in earnings could also be the result of other factors. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Sumitomo Electric Industries' growth is quite high when compared to the industry average growth of 19% in the same period, which is great 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. Doing so will help them establish if the stock's future looks promising or ominous. Is 5802 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Sumitomo Electric Industries Making Efficient Use Of Its Profits?

Sumitomo Electric Industries' three-year median payout ratio is a pretty moderate 37%, meaning the company retains 63% of its income. By the looks of it, the dividend is well covered and Sumitomo Electric Industries is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Sumitomo Electric Industries has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

Overall, we are quite pleased with Sumitomo Electric Industries' performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.