KH Neochem Co., Ltd.'s (TSE:4189) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

KH Neochem (TSE:4189) has had a rough three months with its share price down 13%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to KH Neochem'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.

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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 KH Neochem is:

13% = JP¥9.1b ÷ JP¥71b (Based on the trailing twelve months to June 2025).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ¥1 of its shareholder's investments, the company generates a profit of ¥0.13.

See our latest analysis for KH Neochem

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of KH Neochem's Earnings Growth And 13% ROE

At first glance, KH Neochem seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 7.0%. Yet, KH Neochem has posted measly growth of 2.3% over the past five years. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

As a next step, we compared KH Neochem'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 7.4% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is KH Neochem fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is KH Neochem Making Efficient Use Of Its Profits?

While KH Neochem has a decent three-year median payout ratio of 45% (or a retention ratio of 55%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, KH Neochem has been paying dividends for nine years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

In total, it does look like KH Neochem has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.