Declining Stock and Decent Financials: Is The Market Wrong About Kyoei Security Service Co., Ltd. (TYO:7058)?

It is hard to get excited after looking at Kyoei Security Service's (TYO:7058) recent performance, when its stock has declined 9.2% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Kyoei Security Service'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Kyoei Security Service

How Is ROE Calculated?

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 Kyoei Security Service is:

7.6% = JP¥293m ÷ JP¥3.9b (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax 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?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Kyoei Security Service's Earnings Growth And 7.6% ROE

When you first look at it, Kyoei Security Service's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 7.3%, so we won't completely dismiss the company. On the other hand, Kyoei Security Service reported a moderate 6.7% net income growth over the past five years. 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. For instance, the company has a low payout ratio or is being managed efficiently.

We then performed a comparison between Kyoei Security Service's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 6.6% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Kyoei Security Service fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Kyoei Security Service Efficiently Re-investing Its Profits?

Kyoei Security Service has a three-year median payout ratio of 35%, which implies that it retains the remaining 65% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

While Kyoei Security Service has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Conclusion

In total, it does look like Kyoei Security Service 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. Our risks dashboard would have the 2 risks we have identified for Kyoei Security Service.

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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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