Are Strong Financial Prospects The Force That Is Driving The Momentum In SK Japan Co.,Ltd.'s TSE:7608) Stock?

SK JapanLtd (TSE:7608) has had a great run on the share market with its stock up by a significant 25% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to SK JapanLtd's 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 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 SK JapanLtd

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for SK JapanLtd is:

16% = JP¥856m ÷ JP¥5.3b (Based on the trailing twelve months to November 2024).

The 'return' is the yearly profit. Another way to think of that is that for every ¥1 worth of equity, the company was able to earn ¥0.16 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.

SK JapanLtd's Earnings Growth And 16% ROE

To start with, SK JapanLtd's ROE looks acceptable. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. This probably laid the ground for SK JapanLtd's moderate 16% net income growth seen over the past five years.

As a next step, we compared SK JapanLtd'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 23% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is SK JapanLtd fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is SK JapanLtd Efficiently Re-investing Its Profits?

SK JapanLtd has a low three-year median payout ratio of 20%, meaning that the company retains the remaining 80% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Additionally, SK JapanLtd 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.

Conclusion

In total, we are pretty happy with SK JapanLtd's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 3 risks we have identified for SK JapanLtd by visiting our risks dashboard for free on our platform here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.