Do Its Financials Have Any Role To Play In Driving The Japan Steel Works, Ltd.'s (TSE:5631) Stock Up Recently?

Japan Steel Works' (TSE:5631) stock is up by a considerable 57% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Japan Steel Works' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Japan Steel Works

How To Calculate Return On Equity?

ROE 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 Japan Steel Works is:

11% = JP¥18b ÷ JP¥168b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each ¥1 of shareholders' capital it has, the company made ¥0.11 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. 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.

Japan Steel Works' Earnings Growth And 11% ROE

At first glance, Japan Steel Works seems to have a decent ROE. On comparing with the average industry ROE of 7.4% the company's ROE looks pretty remarkable. However, we are curious as to how the high returns still resulted in flat growth for Japan Steel Works in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 6.6% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for 5631? You can find out in our latest intrinsic value infographic research report.

Is Japan Steel Works Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 31% (or a retention ratio of 69%), Japan Steel Works hasn't seen much growth in its earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Japan Steel Works has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

Overall, we feel that Japan Steel Works certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.