Prime Strategy Co., Ltd.'s (TSE:5250) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 32% over the past three months, it is easy to disregard Prime Strategy (TSE:5250). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Prime Strategy's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Prime Strategy

How Do You 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 Prime Strategy is:

14% = JP¥173m ÷ JP¥1.3b (Based on the trailing twelve months to February 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every ¥1 worth of equity, the company was able to earn ¥0.14 in profit.

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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Prime Strategy's Earnings Growth And 14% ROE

To begin with, Prime Strategy seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 13%. Consequently, this likely laid the ground for the impressive net income growth of 34% seen over the past five years by Prime Strategy. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Prime Strategy's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 14% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Prime Strategy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Prime Strategy Making Efficient Use Of Its Profits?

The three-year median payout ratio for Prime Strategy is 38%, which is moderately low. The company is retaining the remaining 62%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Prime Strategy is reinvesting its earnings efficiently.

Conclusion

Overall, we are quite pleased with Prime Strategy's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial 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. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 3 risks we have identified for Prime Strategy 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com