Are Pacific Systems Corporation's (TYO:3847) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

With its stock down 4.3% over the past three months, it is easy to disregard Pacific Systems (TYO:3847). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Pacific Systems' ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Pacific 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 Pacific Systems is:

6.4% = JP¥318m ÷ JP¥5.0b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. So, this means that for every ¥1 of its shareholder's investments, the company generates a profit of ¥0.06.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Pacific Systems' Earnings Growth And 6.4% ROE

At first glance, Pacific Systems' ROE doesn't look very promising. However, its ROE is similar to the industry average of 5.9%, so we won't completely dismiss the company. On the other hand, Pacific Systems reported a moderate 6.8% net income growth over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Pacific Systems' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 7.8% 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. Doing so will help them establish if the stock's future looks promising or ominous. Is Pacific Systems fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Pacific Systems Efficiently Re-investing Its Profits?

Pacific Systems has a three-year median payout ratio of 31%, which implies that it retains the remaining 69% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Pacific 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.

Conclusion

On the whole, we do feel that Pacific Systems has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. 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. To know the 4 risks we have identified for Pacific Systems 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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