Are Daiwa Computer Co., Ltd.'s (TYO:3816) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

Daiwa Computer (TYO:3816) has had a rough week with its share price down 7.1%. 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 Daiwa Computer's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Daiwa Computer

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 Daiwa Computer is:

7.5% = JP¥308m ÷ JP¥4.1b (Based on the trailing twelve months to January 2021).

The 'return' is the income the business earned over the last year. So, this means that for every ¥1 of its shareholder's investments, the company generates a profit of ¥0.08.

Why Is ROE Important For 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.

Daiwa Computer's Earnings Growth And 7.5% ROE

At first glance, Daiwa Computer's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 12%. Although, we can see that Daiwa Computer saw a modest net income growth of 12% over the past five years. So, there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing Daiwa Computer's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 15% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Daiwa Computer is trading on a high P/E or a low P/E, relative to its industry.

Is Daiwa Computer Using Its Retained Earnings Effectively?

Daiwa Computer's three-year median payout ratio to shareholders is 20% (implying that it retains 80% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Daiwa Computer 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 Daiwa Computer has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard will have the 1 risk we have identified for Daiwa Computer.

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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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