Ryoyu Systems Co., Ltd.'s (TYO:4685) Stock Is Going Strong: Is the Market Following Fundamentals?

Most readers would already be aware that Ryoyu Systems' (TYO:4685) stock increased significantly by 15% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Ryoyu Systems' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Ryoyu Systems

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 Ryoyu Systems is:

14% = JP¥1.5b ÷ JP¥11b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. That means that for every ¥1 worth of shareholders' equity, the company generated ¥0.14 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Ryoyu Systems' Earnings Growth And 14% ROE

At first glance, Ryoyu Systems seems to have a decent ROE. Even when compared to the industry average of 12% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 16% seen over the past five years by Ryoyu Systems.

We then performed a comparison between Ryoyu Systems' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 15% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Ryoyu Systems fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Ryoyu Systems Using Its Retained Earnings Effectively?

Ryoyu Systems has a low three-year median payout ratio of 21%, meaning that the company retains the remaining 79% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Additionally, Ryoyu Systems has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

Overall, we are quite pleased with Ryoyu Systems' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 1 risk we have identified for Ryoyu Systems by visiting our risks dashboard for free on our platform here.

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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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