SL Corporation's (KRX:005850) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Most readers would already be aware that SL's (KRX:005850) stock increased significantly by 95% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study SL'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for SL

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 SL is:

3.3% = ₩46b ÷ ₩1.4t (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. That means that for every ₩1 worth of shareholders' equity, the company generated ₩0.03 in profit.

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.

SL's Earnings Growth And 3.3% ROE

It is hard to argue that SL's ROE is much good in and of itself. An industry comparison shows that the company's ROE is not much different from the industry average of 3.4% either. Given the circumstances, the significant decline in net income by 13% seen by SL over the last five years is not surprising.

We then compared SL's performance with the industry and found that the company has shrunk its earnings at a slower rate than the industry earnings which has seen its earnings shrink by 17% in the same period. This does offer shareholders some relief

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 A005850 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is SL Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 28% (where it is retaining 72% of its profits), SL has seen a decline in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, SL 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 19% over the next three years. As a result, the expected drop in SL's payout ratio explains the anticipated rise in the company's future ROE to 9.5%, over the same period.

Conclusion

On the whole, we feel that the performance shown by SL can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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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