Declining Stock and Solid Fundamentals: Is The Market Wrong About SMS Co., Ltd. (TSE:2175)?

With its stock down 13% over the past month, it is easy to disregard SMS (TSE:2175). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study SMS' ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for SMS

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 SMS is:

15% = JP¥6.2b ÷ JP¥43b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. That means that for every ¥1 worth of shareholders' equity, the company generated ¥0.15 in profit.

Why Is ROE Important For 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. 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.

SMS' Earnings Growth And 15% ROE

To start with, SMS' ROE looks acceptable. Further, the company's ROE is similar to the industry average of 13%. Consequently, this likely laid the ground for the decent growth of 10% seen over the past five years by SMS.

Next, on comparing SMS' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 12% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for 2175? You can find out in our latest intrinsic value infographic research report.

Is SMS Efficiently Re-investing Its Profits?

SMS has a low three-year median payout ratio of 16%, meaning that the company retains the remaining 84% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Additionally, SMS has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

In total, we are pretty happy with SMS' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.