Could The Market Be Wrong About Yahagi Construction Co.,Ltd. (TSE:1870) Given Its Attractive Financial Prospects?

With its stock down 18% over the past month, it is easy to disregard Yahagi ConstructionLtd (TSE:1870). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Yahagi ConstructionLtd'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Yahagi ConstructionLtd

How To 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 Yahagi ConstructionLtd is:

9.7% = JP¥6.5b ÷ JP¥67b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. That means that for every ¥1 worth of shareholders' equity, the company generated ¥0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Yahagi ConstructionLtd's Earnings Growth And 9.7% ROE

To start with, Yahagi ConstructionLtd's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 7.4%. Yet, Yahagi ConstructionLtd has posted measly growth of 4.8% over the past five years. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared Yahagi ConstructionLtd's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 0.6%.

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. If you're wondering about Yahagi ConstructionLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Yahagi ConstructionLtd Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 40% (implying that the company retains the remaining 60% of its income), Yahagi ConstructionLtd's earnings growth was quite low. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Yahagi ConstructionLtd has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

On the whole, we feel that Yahagi ConstructionLtd's performance has been quite good. 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.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com