Cosmo Bio Company,Limited's (TYO:3386) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Cosmo Bio CompanyLimited's (TYO:3386) recent performance, when its stock has declined 6.1% over the past month. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Cosmo Bio CompanyLimited's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Cosmo Bio CompanyLimited

How To Calculate Return On Equity?

ROE 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 Cosmo Bio CompanyLimited is:

8.9% = JP¥701m ÷ JP¥7.9b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each ¥1 of shareholders' capital it has, the company made ¥0.09 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.

Cosmo Bio CompanyLimited's Earnings Growth And 8.9% ROE

To begin with, Cosmo Bio CompanyLimited seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 9.3%. Consequently, this likely laid the ground for the decent growth of 14% seen over the past five years by Cosmo Bio CompanyLimited.

Next, on comparing with the industry net income growth, we found that Cosmo Bio CompanyLimited's growth is quite high when compared to the industry average growth of 6.9% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Cosmo Bio CompanyLimited is trading on a high P/E or a low P/E, relative to its industry.

Is Cosmo Bio CompanyLimited Efficiently Re-investing Its Profits?

Cosmo Bio CompanyLimited has a three-year median payout ratio of 32%, which implies that it retains the remaining 68% 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.

Moreover, Cosmo Bio CompanyLimited is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

In total, we are pretty happy with Cosmo Bio CompanyLimited's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 3 risks we have identified for Cosmo Bio CompanyLimited.

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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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