Will Weakness in Adastria Co., Ltd.'s (TSE:2685) Stock Prove Temporary Given Strong Fundamentals?

Adastria (TSE:2685) has had a rough three months with its share price down 12%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Adastria'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.

Check out our latest analysis for Adastria

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Adastria is:

18% = JP¥13b ÷ JP¥74b (Based on the trailing twelve months to May 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 ¥0.18 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Adastria's Earnings Growth And 18% ROE

To begin with, Adastria seems to have a respectable ROE. Especially when compared to the industry average of 10% the company's ROE looks pretty impressive. This probably laid the ground for Adastria's significant 27% net income growth seen over the past five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Adastria's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 13%.

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. Has the market priced in the future outlook for 2685? You can find out in our latest intrinsic value infographic research report.

Is Adastria Efficiently Re-investing Its Profits?

The three-year median payout ratio for Adastria is 31%, which is moderately low. The company is retaining the remaining 69%. By the looks of it, the dividend is well covered and Adastria is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Adastria has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

On the whole, we feel that Adastria's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.