Can Tamura Corporation's (TSE:6768) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Tamura's (TSE:6768) stock is up by a considerable 22% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study Tamura'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. 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 Tamura

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 Tamura is:

1.4% = JP¥810m ÷ JP¥56b (Based on the trailing twelve months to December 2023).

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 ¥0.01 in profit.

What Is The Relationship Between ROE And 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.

Tamura's Earnings Growth And 1.4% ROE

It is quite clear that Tamura's ROE is rather low. Even when compared to the industry average of 8.1%, the ROE figure is pretty disappointing. For this reason, Tamura's five year net income decline of 41% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared Tamura's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 15% in the same period. This is quite worrisome.

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. 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 Tamura is trading on a high P/E or a low P/E, relative to its industry.

Is Tamura Efficiently Re-investing Its Profits?

Tamura's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 96% (or a retention ratio of 3.8%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 2 risks we have identified for Tamura by visiting our risks dashboard for free on our platform here.

Moreover, Tamura has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

Overall, we would be extremely cautious before making any decision on Tamura. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.