Most readers would already know that Taiyo Koki's (TYO:6164) stock increased by 4.5% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Taiyo Koki's 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.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Taiyo Koki is:
5.4% = JP¥345m ÷ JP¥6.4b (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ¥1 of its shareholder's investments, the company generates a profit of ¥0.05.
Why Is ROE Important For 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.
A Side By Side comparison of Taiyo Koki's Earnings Growth And 5.4% ROE
On the face of it, Taiyo Koki's ROE is not much to talk about. However, its ROE is similar to the industry average of 6.1%, so we won't completely dismiss the company. Even so, Taiyo Koki has shown a fairly decent growth in its net income which grew at a rate of 6.7%. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Taiyo Koki's growth is quite high when compared to the industry average growth of 2.3% 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. 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 Taiyo Koki is trading on a high P/E or a low P/E, relative to its industry.
Is Taiyo Koki Making Efficient Use Of Its Profits?
Given that Taiyo Koki doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
In total, it does look like Taiyo Koki has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for Taiyo Koki visit our risks dashboard for free.
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