Declining Stock and Decent Financials: Is The Market Wrong About Shigematsu Works Co., Ltd. (TYO:7980)?

It is hard to get excited after looking at Shigematsu Works' (TYO:7980) recent performance, when its stock has declined 2.7% over the past week. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Shigematsu Works' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Shigematsu Works

How To Calculate Return On Equity?

Return on equity 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 Shigematsu Works is:

11% = JP¥593m ÷ JP¥5.3b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. That means that for every ¥1 worth of shareholders' equity, the company generated ¥0.11 in profit.

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. 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.

A Side By Side comparison of Shigematsu Works' Earnings Growth And 11% ROE

At first glance, Shigematsu Works seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 7.2%. Despite this, Shigematsu Works' five year net income growth was quite low averaging at only 4.0%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Shigematsu Works' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 6.7% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is 7980 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Shigematsu Works Using Its Retained Earnings Effectively?

Shigematsu Works doesn't pay any dividend, which means that it is retaining all of its earnings. However, this doesn't explain the low earnings growth the company has seen. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Summary

In total, it does look like Shigematsu Works has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the 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. You can see the 2 risks we have identified for Shigematsu Works 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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