Are E-SUPPORTLINK, Ltd.'s (TYO:2493) Mixed Financials Driving The Negative Sentiment?

With its stock down 5.4% over the past three months, it is easy to disregard E-SUPPORTLINK (TYO:2493). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on E-SUPPORTLINK'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for E-SUPPORTLINK

How To Calculate Return On Equity?

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 E-SUPPORTLINK is:

2.8% = JP¥116m ÷ JP¥4.1b (Based on the trailing twelve months to November 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every ¥1 of its shareholder's investments, the company generates a profit of ¥0.03.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of E-SUPPORTLINK's Earnings Growth And 2.8% ROE

On the face of it, E-SUPPORTLINK's ROE is not much to talk about. Next, when compared to the average industry ROE of 12%, the company's ROE leaves us feeling even less enthusiastic. Therefore, it might not be wrong to say that the five year net income decline of 39% seen by E-SUPPORTLINK was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared E-SUPPORTLINK's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 15% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if E-SUPPORTLINK is trading on a high P/E or a low P/E, relative to its industry.

Is E-SUPPORTLINK Efficiently Re-investing Its Profits?

E-SUPPORTLINK's low three-year median payout ratio of 22% (implying that it retains the remaining 78% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, E-SUPPORTLINK has been paying dividends for four years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Summary

Overall, we have mixed feelings about E-SUPPORTLINK. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 3 risks we have identified for E-SUPPORTLINK 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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