Pacific Systems Corporation's (TSE:3847) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Pacific Systems' (TSE:3847) stock is up by a considerable 15% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Pacific Systems' ROE.

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

Check out our latest analysis for Pacific Systems

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Pacific Systems is:

9.3% = JP¥571m ÷ JP¥6.2b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every ¥1 worth of equity, the company was able to earn ¥0.09 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Pacific Systems' Earnings Growth And 9.3% ROE

To start with, Pacific Systems' ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 8.4%. Despite this, Pacific Systems' five year net income growth was quite flat over the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. These include low earnings retention or poor allocation of capital.

As a next step, we compared Pacific Systems' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 16% 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). 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 Pacific Systems is trading on a high P/E or a low P/E, relative to its industry.

Is Pacific Systems Making Efficient Use Of Its Profits?

Despite having a moderate three-year median payout ratio of 46% (meaning the company retains54% of profits) in the last three-year period, Pacific Systems' earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Pacific Systems has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Summary

On the whole, we do feel that Pacific Systems has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. Up till now, we've only made a short study of the company's growth data. To gain further insights into Pacific Systems' past profit growth, check out this visualization of past earnings, revenue and cash flows.

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

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.