Should Weakness in JAPAN MATERIAL Co., Ltd.'s (TSE:6055) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 11% over the past three months, it is easy to disregard JAPAN MATERIAL (TSE:6055). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to JAPAN MATERIAL's ROE today.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for JAPAN MATERIAL

How Do You 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 JAPAN MATERIAL is:

13% = JP¥6.1b ÷ JP¥48b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ¥1 of its shareholder's investments, the company generates a profit of ¥0.13.

Why Is ROE Important For 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. 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.

JAPAN MATERIAL's Earnings Growth And 13% ROE

To start with, JAPAN MATERIAL's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 12%. Despite the moderate return on equity, JAPAN MATERIAL has posted a net income growth of 4.7% over the past five years. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.

We then compared JAPAN MATERIAL's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 26% in the same 5-year period, which is a bit concerning.

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. This then helps them determine if the stock is placed for a bright or bleak future. What is 6055 worth today? The intrinsic value infographic in our free research report helps visualize whether 6055 is currently mispriced by the market.

Is JAPAN MATERIAL Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 27% (implying that the company retains the remaining 73% of its income), JAPAN MATERIAL's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, JAPAN MATERIAL 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

In total, it does look like JAPAN MATERIAL has some positive aspects to its business. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.