Does The Market Have A Low Tolerance For NEXON Co., Ltd.'s (TSE:3659) Mixed Fundamentals?

With its stock down 2.8% over the past month, it is easy to disregard NEXON (TSE:3659). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on NEXON's ROE.

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.

See our latest analysis for NEXON

How Is ROE Calculated?

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 NEXON is:

6.7% = JP¥69b ÷ JP¥1.0t (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every ¥1 worth of equity, the company was able to earn ¥0.07 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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

NEXON's Earnings Growth And 6.7% ROE

When you first look at it, NEXON's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.9%. But then again, NEXON's five year net income shrunk at a rate of 3.2%. 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 NEXON's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 9.5% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for 3659? You can find out in our latest intrinsic value infographic research report.

Is NEXON Making Efficient Use Of Its Profits?

NEXON's low three-year median payout ratio of 7.7% (or a retention ratio of 92%) 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. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

In addition, NEXON has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

Overall, we have mixed feelings about NEXON. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.