Software Service, Inc.'s (TYO:3733) Stock Has Shown A Decent Performance: Have Financials A Role To Play?

Software Service's (TYO:3733) stock up by 4.2% over the past week. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Particularly, we will be paying attention to Software Service's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Software Service

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Software Service is:

9.9% = JP¥2.2b ÷ JP¥23b (Based on the trailing twelve months to July 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every ¥1 worth of equity, the company was able to earn ¥0.10 in profit.

What Has ROE Got To Do With 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Software Service's Earnings Growth And 9.9% ROE

At first glance, Software Service seems to have a decent ROE. Even so, when compared with the average industry ROE of 15%, we aren't very excited. Although, we can see that Software Service saw a modest net income growth of 9.2% over the past five years. Therefore, the growth in earnings could probably have been caused by other variables. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also does lend some color to the fairly high earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that Software Service's reported growth was lower than the industry growth of 28% in the same period, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Software Service is trading on a high P/E or a low P/E, relative to its industry.

Is Software Service Using Its Retained Earnings Effectively?

Software Service doesn't pay any dividend, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.

Conclusion

On the whole, we do feel that Software Service has some positive attributes. Particularly, its earnings have grown respectably as we saw earlier, which was likely achieved due to the company reinvesting most of its earnings at a decent rate of return, to grow its business.

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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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