Declining Stock and Decent Financials: Is The Market Wrong About USS Co., Ltd. (TSE:4732)?

It is hard to get excited after looking at USS' (TSE:4732) recent performance, when its stock has declined 15% over the past three months. 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 USS' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for USS

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 USS is:

18% = JP¥33b ÷ JP¥190b (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. 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 Is The Relationship Between ROE And 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. 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.

USS' Earnings Growth And 18% ROE

At first glance, USS seems to have a decent ROE. On comparing with the average industry ROE of 9.7% the company's ROE looks pretty remarkable. This certainly adds some context to USS' decent 7.6% net income growth seen over the past five years.

We then compared USS' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 13% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 4732? You can find out in our latest intrinsic value infographic research report.

Is USS Using Its Retained Earnings Effectively?

While USS has a three-year median payout ratio of 58% (which means it retains 42% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Moreover, USS 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.

Conclusion

In total, it does look like USS has some positive aspects to its business. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. 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.