Is Koken Boring Machine Co.,Ltd.'s (TYO:6297) Latest Stock Performance A Reflection Of Its Financial Health?

Most readers would already be aware that Koken Boring MachineLtd's (TYO:6297) stock increased significantly by 24% 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. Particularly, we will be paying attention to Koken Boring MachineLtd's ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Koken Boring MachineLtd

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 Koken Boring MachineLtd is:

22% = JP¥1.0b ÷ JP¥4.7b (Based on the trailing twelve months to December 2020).

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 ¥0.22 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Koken Boring MachineLtd's Earnings Growth And 22% ROE

First thing first, we like that Koken Boring MachineLtd has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 5.8% also doesn't go unnoticed by us. Despite this, Koken Boring MachineLtd's five year net income growth was quite low averaging at only 4.7%. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or or poor allocation of capital.

We then compared Koken Boring MachineLtd's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 2.7% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Koken Boring MachineLtd is trading on a high P/E or a low P/E, relative to its industry.

Is Koken Boring MachineLtd Efficiently Re-investing Its Profits?

A low three-year median payout ratio of 21% (implying that the company retains the remaining 79% of its income) suggests that Koken Boring MachineLtd is retaining most of its profits. This should be reflected in its earnings growth number, but that's not the case. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Koken Boring MachineLtd has been paying dividends for six years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we are quite pleased with Koken Boring MachineLtd's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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. You can see the 3 risks we have identified for Koken Boring MachineLtd 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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