Could The Market Be Wrong About Nippon Ichi Software, Inc. (TYO:3851) Given Its Attractive Financial Prospects?

It is hard to get excited after looking at Nippon Ichi Software's (TYO:3851) recent performance, when its stock has declined 5.8% over the past month. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Nippon Ichi Software's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Nippon Ichi Software

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 Nippon Ichi Software is:

15% = JP¥605m ÷ JP¥4.1b (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. That means that for every ¥1 worth of shareholders' equity, the company generated ¥0.15 in profit.

What Has ROE Got To Do With 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.

Nippon Ichi Software's Earnings Growth And 15% ROE

At first glance, Nippon Ichi Software seems to have a decent ROE. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. This probably laid the ground for Nippon Ichi Software's moderate 9.2% net income growth seen over the past five years.

Next, on comparing Nippon Ichi Software's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 8.5% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Nippon Ichi Software fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Nippon Ichi Software Using Its Retained Earnings Effectively?

Nippon Ichi Software's three-year median payout ratio to shareholders is 4.3% (implying that it retains 96% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Nippon Ichi Software 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

Overall, we are quite pleased with Nippon Ichi Software's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 1 risk we have identified for Nippon Ichi Software visit our risks dashboard for free.

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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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