Sk Kaken Co.,Ltd.'s (TYO:4628) Has Performed Well But Fundamentals Look Varied: Is There A Clear Direction For The Stock?

Sk KakenLtd's (TYO:4628) stock is up by 1.0% over the past month. However, we decided to study the company's mixed-bag of fundamentals to assess what this could mean for future share prices, as stock prices tend to be aligned with a company's long-term financial performance. Specifically, we decided to study Sk KakenLtd's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Sk KakenLtd

How Do You Calculate Return On Equity?

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 Sk KakenLtd is:

5.0% = JP¥6.0b ÷ JP¥120b (Based on the trailing twelve months to December 2020).

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 ¥0.05 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

A Side By Side comparison of Sk KakenLtd's Earnings Growth And 5.0% ROE

At first glance, Sk KakenLtd's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 5.5%. Having said that, Sk KakenLtd's five year net income decline rate was 2.9%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

However, when we compared Sk KakenLtd's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 0.7% in the same period. This is quite worrisome.

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. If you're wondering about Sk KakenLtd's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Sk KakenLtd Efficiently Re-investing Its Profits?

Sk KakenLtd's low three-year median payout ratio of 3.6% (or a retention ratio of 96%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Moreover, Sk KakenLtd has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

On the whole, we feel that the performance shown by Sk KakenLtd can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard will have the 1 risk we have identified for Sk KakenLtd.

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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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