Declining Stock and Decent Financials: Is The Market Wrong About Nihon Seiko Co., Ltd. (TSE:5729)?

Nihon Seiko (TSE:5729) has had a rough week with its share price down 12%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Nihon Seiko's ROE.

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.

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How Do You 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 Nihon Seiko is:

13% = JP¥1.4b ÷ JP¥11b (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. That means that for every ¥1 worth of shareholders' equity, the company generated ¥0.13 in profit.

View our latest analysis for Nihon Seiko

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.

Nihon Seiko's Earnings Growth And 13% ROE

At first glance, Nihon Seiko seems to have a decent ROE. Especially when compared to the industry average of 6.3% the company's ROE looks pretty impressive. Despite this, Nihon Seiko's five year net income growth was quite low averaging at only 4.2%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Nihon Seiko's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 16% in the same 5-year period, which is a bit concerning.

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

Is Nihon Seiko Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 27% (or a retention ratio of 73% over the past three years, Nihon Seiko has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, Nihon Seiko 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

Overall, we feel that Nihon Seiko certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 3 risks we have identified for Nihon Seiko.

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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.