Rinnai Corporation's (TSE:5947) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Most readers would already be aware that Rinnai's (TSE:5947) stock increased significantly by 10% over the past week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Rinnai's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Rinnai

How Is ROE Calculated?

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 Rinnai is:

6.9% = JP¥29b ÷ JP¥424b (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ¥1 of shareholders' capital it has, the company made ¥0.07 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Rinnai's Earnings Growth And 6.9% ROE

On the face of it, Rinnai's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.1%. Having said that, Rinnai has shown a meagre net income growth of 3.4% over the past five years. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.

As a next step, we compared Rinnai's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 4.3% 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). This then helps them determine if the stock is placed for a bright or bleak future. Is Rinnai fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Rinnai Using Its Retained Earnings Effectively?

While Rinnai has a decent three-year median payout ratio of 27% (or a retention ratio of 73%), it has seen very little growth in earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Rinnai 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.

Conclusion

In total, we're a bit ambivalent about Rinnai's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.